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Research in Transportation Economics 22 (2008) 61–70

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Research in Transportation Economics

journal homepage: www.elsevier .com/locate/retrec

Passenger railway reform in the last 20 years – Europeanexperience reconsidered

Chris NashInstitute for Transport Studies, University of Leeds, Leeds, UK

Keywords:RailReformEurope

E-mail address: c.a.nash@its.leeds.ac.uk

0739-8859/$ – see front matter � 2008 Elsevier Ltd.doi:10.1016/j.retrec.2008.05.020

a b s t r a c t

It is about 20 years since the rail reform process in Europe began with the separation of infrastructurefrom operations in Sweden. This paper reviews the entire process, examining the objectives of reform,the different models adopted, and the key elements of separation of infrastructure from operations,competition both through open access and franchising and regulation and infrastructure charging. It isconcluded that separation of infrastructure from operations involves costs, but is the most effective wayof achieving within mode competition. Where operations do not greatly overlap and open accesspassenger and freight are unimportant, leasing infrastructure to passenger franchisees may be effective,but the model of vertical integration as separate subsidiaries within a holding company structure makesit difficult to ensure a level playing field for new entrants and is only effective where the verticallyintegrated operator remains dominant.

� 2008 Elsevier Ltd. All rights reserved.

1. Introduction

The current round of rail reforms in Europe began almost 20years ago, with the separation of infrastructure from operations inSweden. Further major developments were the separation ofinfrastructure from operations in Britain and the complete priva-tisation of these, with comprehensive passenger franchising, andthe formation of Deutsche Bahn AG as a holding company, withseparate passenger, freight and infrastructure subsidiaries andopportunities for new passenger operators both on an open accesscommercial and a franchised basis. Less radical changes havefollowed in many other countries, and indeed European legislationnow requires at least separate accounts for infrastructure andoperations and a separation of powers whereby key decisionsregarding infrastructure charging and slot allocation may not betaken by an infrastructure manager that is also involved in trainoperations as an integrated company.

Previous papers at Thredbo conferences (e.g. Nash, 2007) havepresented these reforms as they have unfolded. The aim of thispaper is to reflect on the whole process to date. The next sectionconsiders the objectives behind the reforms. We then examine inturn the alternative models that have emerged, and the key ele-ments of the reform (separation of infrastructure from operations,competition in the passenger market, regulation and infrastructurecharging) before reaching an assessment and conclusions.

All rights reserved.

2. Objectives of reform

Whilst it is clear that the fundamental aim of the reforms hasbeen to improve the efficiency and competitiveness of the Euro-pean rail system, it is important to realise that there are keydifferences in approach as to how this was to be accomplished. Forinstance, at the European level, the aim of reform has never been tosecure rail privatisation (the Treaty of Rome forbids the EuropeanCommission from taking a view on ownership) and indeed theintroduction of competition has only been one of a number ofobjectives of the Commission and not necessarily an objective at allof all the member states. At least four other objectives can beidentified.

An initial concern of the Commission was the failure of the railsystem to secure its potential market share in international traffic.This was believed to be because traditionally international traffichad been operated by agreements between the national railwaysthat simply handed traffic over from one national company to an-other at borders. No one took responsibility for the through transitand delays at borders were common. This was always more of anargument regarding freight than passenger traffic, however, and inthe passenger sector there have been seamless jointly operatedinternational operations (e.g. Eurostar, Thalys) for many years.

Of more concern in the passenger sector has been the desire todistinguish clearly the role of government from that of theinfrastructure manager and the train operator. For many decades,European legislation has required that rail companies be consti-tuted as arms length commercial organisations, with realistic

Table 1Alternative model of rail restructuring

Complete separation(the Swedish model)

Holding company(the German model)

Separation of key powers(the French model)

Britain Austria CzechFinland Belgium EstoniaDenmark Italy HungaryNetherlands Latvia SloveniaNorway Poland LuxembourgSpain GreecePortugalSlovakiaLithuania

Ireland and Northern Ireland remain vertically integrated.Source: CEC (2006).

C. Nash / Research in Transportation Economics 22 (2008) 61–7062

accounts and with any public service obligations imposed ina transparent way and fully compensated by the state. In manycountries (Sweden, Germany, France, at one time Britain) this hasled to a clear distinction between commercial passenger services,where the operator is free to choose the timetable and fares to becharged, and subsidised ones, where these factors are set toa greater or lesser degree by the state. Freight is generally regardedas a commercial activity. However, since it is the case that around90% of European rail passenger services are subject to a publicservice obligation (CER, 2005), it is the subsidised services thatdominate and that determine the key characteristics of the railnetwork in terms of size and capability.

The result is that the state is inevitably heavily concerned in longterm decisions on the financing and planning of and investment inthe infrastructure. In this context, the arms–length relationship isdifficult. One reason for the separation of infrastructure andoperations in many countries is that the planning and financing ofthe infrastructure are seen as essentially a state role, whilst theoperation of services can be a commercial or subsidised contractualactivity. Thus in many countries medium term contracts have beenestablished which set out what the infrastructure manager is to doand how it is to be financed. In Britain this is achieved via theperiodic review conducted by the Regulator, into which the gov-ernment now inputs an explicit specification of what the capabilityof the network should be (the High Level Output Specification orHLOS) and the statement of funds available (SOFA). It is for theRegulator to resolve any incompatibility between these two.

A further objective of reform clearly stated by the Swedishgovernment when it separated rail infrastructure from operationswas the desire to put inter modal competition on a level playingfield, by planning and financing road and rail infrastructure usingthe same cost–benefit framework, with both funded from generaltaxation and with users charged their marginal social costs.

In the field of passenger services, a key feature of reform inmany countries has been the regionalisation of some or all sub-sidies. Thus in France and Germany, all subsidies are now paid bythe regional level of government; in Sweden most are and in manyother countries (including Britain) some subsidy decisions havebeen decentralised from the single national government. Thisprocess has the merit of putting decisions in the hands of the levelof government best placed to understand the needs of the localpopulation. But it further complicated relationships in the railindustry, by meaning that the tier of government most concernedwith planning the infrastructure may be different from that mostconcerned with specifying services, and by making infrastructurecost allocation between regional and long distance services a muchmore controversial issue.

The result of these reforms is that many passenger services areprovided on a clear contractual basis either to central or regionalgovernment. Of course, the next obvious step in the reform is toallow contracting bodies to market test the subsidy level needed forthe services through a franchising system. In most cases, particu-larly for regional services, the aim of franchising has simply been touse the forces of competition to secure high quality delivery of thespecified service at reduced cost. But where long distance servicesare franchised it is common to give the operator more control overfares and services, so that the franchise competition is not solelyabout cost and delivery but also about fares and service planningand innovation. Whilst the European Commission has never beenable to secure agreement to require subsidised services to befranchised through competitive tendering, this process has beenintroduced in a number of European countries.

Finally in terms of objectives for reform we reach the aim ofintroducing direct on the tracks competition between companiesoperating over the same tracks. This has been an important aim ofreform as regards freight services, where it has had some success.

But for passenger services, the impact of this form of competitionremains negligible. Only the short lived Lover’s Rail operation in theNetherlands and a handful of services in Britain and Germany havebeen operated by entrants to the market on this basis. Nevertheless,it remains an objective of the Commission and the EuropeanParliament to introduce on-track competition initially for in-ternational passenger services (but including domestic journeys oninternational trains) and later for national passenger services.

In the following section we consider the different models thathave emerged to fulfil these various objectives.

3. The different models

It will be apparent from the above that there is no requirement tocompletely separate infrastructure from operations, although if theinfrastructure manager is also an operator then there is a requirementfor an independent body to allocate capacity and set infrastructurecharges. In practice, essentially three different models have emerged.These may be named the Swedish, French and German models, afterthe countries that pioneered them (Table 1).

As already stated, in 1989 Sweden took the infrastructure awayfrom its major rail operator and placed it in a completely separatestate-owned organisation, Banverket. At the time the aim was notso much to do with competition within the rail industry as withachieving fair competition between rail and road and withconcentrating non-commercial issues with the infrastructuremanager leaving the train operating company free to behavecommercially (Alexandersson & Hulten, 2005).

As will be seen from Table 1, a number of countries, mostly innorthern and western Europe, followed the Swedish model, thoughwith detailed differences. Of these, only Britain took the steps ofbreaking up and privatising its train operating company as well asprivatising the infrastructure. In every other case a state-ownedinfrastructure manager continued to co-exist with a state-ownedmajor train operating company, leading to doubts in some cases asto how independent they really were. Britain was also unique incompletely reorganising as well as privatising its railways in just 3years (1994–1997). At the other extreme, Sweden started itsreforms in 1989, but only took the latest step of separating thestate-owned train operating company into completely independentpassenger and freight companies in 2004.

The exact degree of the split between infrastructure andoperations also differed to some extent. Originally in Sweden themain operator remained responsible for timetabling and trafficcontrol. But as competition increased this function was moved toBanverket, as indeed under current legislation is required.

The second model, the German model, retains infrastructureand train operations within the same holding company, but asseparate divisions. Although this structure remains the subject ofhot debate both within Germany, where doubts are being raised as

Table 2Differing degrees of integration

Allocation of responsibilities(separated or integrated)

Swedish German French

Investment S (I) STimetabling S (I) SMaintenance & renewal S (I) ITrain control S (I) ISafety S (I) I

S¼ separated.I¼ integrated with main operator under contract from the infrastructure manager.(I)¼ integrated with main operator but in separate subsidiaries.

C. Nash / Research in Transportation Economics 22 (2008) 61–70 63

to its suitability for privatisation, and at the European level as towhether it really provides the required degree of independence forthe capacity allocation and charging activities, several othercountries, mainly within Central and Eastern Europe, have followedthis model. It is argued that it retains the benefit of an integratedrailway, whilst still permitting competition through the openaccess conditions (Kirchner, 2005).

The third model, the French model, is in one sense more curious,in that it involves a degree of separation of infrastructure fromoperations, but – at least initially – no competition. It comprisesa separate infrastructure manager but one which in turnsubcontracts much of its activity to the major operator. In France,this originally included timetabling and traffic control as well as allmaintenance and renewal work. Of course the infrastructuremanager now has to take responsibility for capacity allocation andcharging. The aim of this model seems to be to create a separatesource of expertise on rail infrastructure planning and investmentissues and to separate financing of the infrastructure from opera-tions, whilst – originally at least – maintaining a monopoly trainoperating company which still retained integrated control of manyfunctions (Gressier, 2005). It is a model which has been followed insome other parts of the world, such as Vietnam and Indonesia,where there has been a wish to identify infrastructure planning andfinance as a government issue but operations as a commercial one.

What are the advantages and disadvantages of the differentapproaches? We will consider these in terms of the key charac-teristics of reform – the degree of separation of infrastructure fromoperations, open access, passenger franchising, regulation andinfrastructure charging.

4. Separation of infrastructure from operations

It has already been seen that separation of infrastructure fromoperations was regarded in some countries as offering benefits inessentially separating out the infrastructure planning and financerole, which was seen as one in which the government had a stronginterest, from the more commercial train operating role. More thanthis, sometimes it is argued that vertical separation has benefits inits own right by creating more specialisation and transparency, butthe fact that almost no commercial railway, including the privatelyowned railways of North America, has voluntarily gone that wayseems to throw great doubt on this hypothesis. Rather the advan-tage must be that it is easier to ensure equal terms of competitionbetween different operators when no operator has more controlover the infrastructure than any other. Thus we may expect there tobe costs involved in vertical separation which may or may not bejustified in terms of the benefits of greater competition. These costsmay take the form of classic transactions costs – the negotiation,monitoring and enforcement of contracts – but also of poordecisions. The interesting question is whether these costs differ inthe different models.

Bouf, Crozet, and Leveque (2005) argue that the main areas inwhich conflicts between infrastructure managers and trainoperators may occur are the following:

� network changes,� access and timetable establishment,� delays and disruption.

On network changes, it is necessary to reach an agreementregarding what investments are necessary, the financing ofinvestment which benefits more than one stakeholder, and how itis to be undertaken. It is not just infrastructure investment that isrelevant here; rolling stock investment also has implications for theinfrastructure manager in terms of power requirements and trackwear and tear.

Regarding access and timetabling, the key problem is to achievethe best possible compromise between the requirements of thedifferent operators, whilst levying charges which provide appro-priate incentives and raise the necessary amount of revenue.

Delays and disruption raise issues of the planning of mainte-nance and renewal of the system, where a balance is requiredbetween the efficient planning of engineering work and minimis-ing disruption to train operators, and of real time train control,where a balance is needed between the interests of the differentoperators. A real problem may be that the infrastructure managerhas inadequate knowledge of the consequences, particularly knockon effects, of delays to different trains, and inadequate incentives totake these into account.

A fourth area which might be added is safety, where theallocation of responsibilities must be clear and a balance is neededbetween costs and effectiveness. It may be that an independentinfrastructure manager has an incentive to impose excessive safetyrequirements, where the costs will be borne by third parties, suchas in the introduction of new rolling stock.

Table 2 shows the extent to which these different activitiesare integrated in the different models. The German model retainscomplete integration within the holding company, and theFrench model retains integration except for timetabling and in-vestment planning. It has been argued that all these interactionsare much simpler and more effective if they are retained withina vertically integrated railway, since they will remaintransactions between parties whose ultimate interest is theprofitability of the company as a whole (though it might be notedthat vertically integrated companies do not necessarily work inthis way, at any rate when divided into separate subsidiaries withtheir own objectives and their own accounts). However, oncecompetition is permitted, it appears that any such benefits relyon the integrated company remaining dominant in trainoperations. Otherwise, for many operations there will in fact bevertical separation. The argument for a vertically integratedstructure with open access is then essentially that one can retainthe benefits of integration whilst introducing enough competi-tion to enforce efficiency on the dominant operator withoutremoving its dominance.

Where these activities are vertically separated clearly it isimportant that the precise arrangements for them and theincentives built into the contractual arrangements are as effectiveas possible. Appropriate infrastructure charges and compensationpayments for disruption due to engineering work or out of courserunning will go a long way to correcting incentives, but possibly atthe expense of greatly increased transaction costs. Disputesprocedures are also important; somewhat surprisingly, given themuch greater degree of competition in Britain than in France, Boufet al. (2005) conclude that the disputes procedures in Britain, whichrely heavily on industry wide committees, are more likely tohamper competition by encouraging cartelisation than the morehierarchical procedures in France.

C. Nash / Research in Transportation Economics 22 (2008) 61–7064

We have already commented above that one of the mainarguments for vertical separation is to facilitate competition byensuring that the infrastructure manager has no incentive to favourone train operating company over another. The argument is mostclear in the case of open access competition, although it may still beargued that a strong Regulator could ensure a level playing field inthis case. It is less clear in the case of franchising, which we haveseen is the dominant form of competition in the passenger sector. Ifthe network could be clearly divided into self-contained regions,then it would be possible to lease the infrastructure in that regionto the franchisee. This would create a pattern similar to that foundin Japan, where there are regional vertically integrated passengeroperators – although not on the basis of franchising – or SouthAmerica, where regional freight franchisees take control of theinfrastructure. The franchisee might be responsible simply for dayto day train control and track maintenance, or possibly also for longterm renewals and enhancement as well. Of course, under EU lawthe train operator could not in these circumstances be responsiblefor slot allocation and infrastructure charging. In practice, sucha clear cut division into regions is seldom possible, and in mostcountries some running of trains of one franchisee over trackscontrolled by another would remain necessary. There is also theissue of freight operators. But this approach to vertical integration ismuch discussed in Britain, and it appears that the Conservativeparty (which was responsible for the current structure of theindustry) favours it, whilst the Labour Party (which opposed thecurrent structure) is now in favour of staying as we are.

5. Competition in passenger markets

As seen above, there is no requirement in current legislation toopen the passenger market to competition either through openaccess or through competitive franchising. However, many coun-tries have done so (Table 3). On the other hand, whilst there isa requirement going back to 1969 that public service obligationsshould be clearly set out in advance and compensated for, CER(2005) report that this is not always happening in new memberstates where governments short of funds expect social passengerservices to be cross subsidised by freight. According to CER (2005)some 90% of passenger km in Europe are carried under some sort ofpublic service obligation, so the extent of purely commercial railpassenger operators is very limited. Perhaps it is therefore notsurprising that in the few cases where open access to the passengermarket is available it has been little used. In Britain, open access ispermitted subject to the agreement of the Regulator that it is in thepublic interest, which generally means that it generates new railtraffic rather than simply diverting traffic from existing operators.Two new entrants – Hull Trains and Grand Central – have beengiven slots on the East Coast Main line, on the basis that theyprovide through services to places not directly served by thefranchised operator, but the franchised operator has arguedstrongly that this will abstract revenue and thus ultimately impacton the government budget when the franchise is relet. In Germanyopen access has existed since 1994, with no such restrictions tolimited circumstances as applied in Britain, but only a handful of

Table 3Extent of franchising

Substantial Limited

Great Britain AustriaEstonia ItalySweden PortugalGermany SwitzerlandDenmark NorwayNetherlands

Source: ECMT (2005).

trains per day have ever been run under this provision. Even whereprofitable ‘cherry picking’ might have occurred, it has not, newentry targeting more gaps in existing services. Again there havebeen disputes about access to facilities such as cleaning andprovision of information, but although the entrants have won thesedisputes it has not encouraged further entry. It appears that thebasic lack of profitability of many passenger services, plus theadvantages possessed by a large network operator, tend to confineopen access operation to limited niche markets (the rapid demise ofthe Lovers Rail open access operator in the Netherlands furthersthis impression – Van der Velde, 2005).

Much more important is franchising. The principal argumentfor franchising by means of competitive tendering is that itpermits the preservation of a network of services planned by thefranchising authority, subsidised where necessary, whilst stillintroducing competitive pressures, leading to incentives to reducecosts and (depending on who bears the revenue risk and whatother incentives are in place) improve quality of service. Thus it isparticularly used for subsidised services. Its extent ranges fromalmost all services in Britain, through all subsidised services inSweden to a single service in Portugal. In Sweden, regionalservices are procured by regional authorities on gross cost con-tracts; unprofitable long distance services by national governmenton net cost contracts (Alexandersson & Hulten, 2005). By 2005,the government-owned operator (SJ) had lost around half ofregional services to several new operators, whilst it retained 87%of long distance services; no competition is permitted in unsub-sidised markets. In Germany, states are responsible for allsubsidised services and may use competitive tendering if theywish. In many areas, they negotiate directly with DB for provisionof services, but some 13% of regional train km are provided byindependents and they tend to win around 50% of those servicesput out to competitive tender (DB, 2006). Denmark and theNetherlands are gradually extending competitive tendering offtheir core networks.

It should be noted that there are some major differencesbetween franchising in Britain and in other European countries. Inmost cases, franchises are for single routes or for much smallernetworks of services than in Britain. In every other case, newentrants bidding for a franchise are competing with the existingdominant operator; this was not allowed in the first round offranchising in Britain. Moreover, if a new entrant wins the franchisethey do not simply take control of an existing company as in Britain.They have to start from scratch recruiting staff and acquiring rollingstock. Nor is there such an active leasing market in passengerrolling stock in most countries as in Britain. Thus perhaps it is notsurprising that the number of bidders is typically much less than inBritain.

Nevertheless, in both Germany and Sweden competitive ten-dering has been regarded as a success, with improved services andsubsidies reduced by some 20% (ECMT, 2005). But both countrieshave experienced some problems:

� companies that have won a bid could not provide the servicesdue to lack of staff or rolling stock;� allegations of predatory pricing in bids both by incumbents and

large new entrants;� unrealistic bids where companies could not survive on the

amount of subsidy in the bid.

The problems with franchising have perhaps been at their mostacute in Britain, where a number of companies have been unable tofulfil the terms of their original franchise agreement, and where allthe gains in cost reduction made in the early years of franchisinghave subsequently been lost through cost increases (Nash & Smith,2007).

C. Nash / Research in Transportation Economics 22 (2008) 61–70 65

If it is decided to franchise passenger services, there are manyissues about the best way to do it. Key questions are:

� What pattern of franchise length, control of services and faresand responsibility for investment is best?� How large a network should each franchise cover?� How may appropriate incentives be built in to the contract?

So far there is a wide variation in practice on such issues. Acommonly identified problem with separation of infrastructurefrom operations in the literature is the so-called ‘‘hold-up’’ problemthat when the downstream party invests the upstream one has theincentive to try reap the benefits of that investment by highercharges (and vice versa). There are a number of ways of trying toavoid this in the rail sector. Firstly, separation of infrastructure fromoperations leads to a situation where rail infrastructure is inseparate, typically government, ownership, with investment andpricing both regulated on public interest criteria. Secondly, whilstaccess agreements are normally limited to 5 years, the legislationprovides for agreements to be up to 10 years or even longer whennecessary to secure investment. Thirdly, in some countries an activeleasing market has been achieved for railway rolling stock(particularly in Britain, where virtually all rolling stock is leased); inothers rolling stock for franchised regional services is often ownedby the franchising authority (in Sweden, the regional authoritiesjointly own a rolling stock leasing company, whilst rolling stock forfranchised long distance services is leased from the state).

Regarding incentives, it is common to use short gross costcontracts for regional services, where all fares and timetablingdecisions are taken by the franchising authority, but longer net costcontracts for long distance services. Britain now recognises thatmany drivers of revenue growth are outside the control of theoperator by sharing revenue risk.

The differences in approach to franchising of three countries –Britain, Germany and Sweden – are illustrated in Table 4.

Nevertheless, it must be accepted that when a franchise issigned, knowledge of future circumstances that will pertain cannotbe perfect, and thus situations are likely to arise in which detailshave to be renegotiated, for instance because changed circum-stances mean that the government want to ensure a different levelof service. This is the problem of incomplete contracts (Williamson,1999). Although contracts may specify rules for proceeding in suchcircumstances (for instance, that changes should be on the basisthat the profitability of the franchisee is unaffected), suchrenegotiations obviously give rise to the risk of opportunisticbehaviour by either party.

Table 5Regulatory models

Ministry Railway authority Special regulatoryauthority

6. Regulation

A recent review of rail regulation in Europe (IBM, 2006) givesthe principal objectives of rail regulation as being:

� to ensure that infrastructure managers have the resources tosafeguard rail infrastructure assets in the long term;

Table 4Alternative approaches to franchising

Contract length Ownership ofrolling stock

Revenue risk

Great Britain Medium (7–10 years) Leasing company Operator/sharedSweden

(regional services)Short (up to 5 years) Regional

authorityRegionalauthority

Sweden (longdistance services)

Short(up to 5 years)

State Operator

Germany Varies but typicallyz10 years

TOC or leased Varies

� to ensure non-discriminatory access;� to ensure efficient infrastructure provision;� to prevent the earning of monopoly profits from infrastructure

charges.

The review finds three regulatory models – the special regula-tory authority model, the railway authority model and the Ministrymodel. The special authority model is characterised by theexistence of an independent authority specialising in regulatorymatters and with adequate powers to enforce its decisions. Of thethree regulatory models, it is thus the best positioned to meet thecriteria set out above. The railway authority model entrusts regu-lation to a body whose traditional functions have often been moreadministrative and may therefore be lacking in regulatory skills. Itmay also be rather close to the incumbent rail operator. TheMinistry model may fail all the above criteria, being often short ofstaff and expertise, lacking powers to do more than make recom-mendations and particularly susceptible to political intervention. Itso happens that our three prototypical countries for the differentreform models also follow three different approaches to regulation,although there is no consistent mapping of different models on todifferent regulatory structures for Europe as a whole (Table 5).

Directive 2001/14 specifically permits the regulatory function tobe located within the Ministry, provided that it is independent fromany ‘infrastructure manager, charging body, allocation body orapplicant’. Thus independence from political control is notrequired. Most of the railways with the Ministry model are thosewhere reform has been slow. Thus – as in France – the Ministry maybe directly responsible for the infrastructure manager andincumbent operator, giving rise to doubts about how independentthe regulatory body is. Estonia is an exception, in that the railwayhad been substantially privatised as a vertically integrated freightnetwork with separate passenger franchisees.

However, it is an example that shows precisely the risks in thisstructure, in that when the private operator came into dispute withthe government concerning the terms on which open access was tobe offered to other freight operators, there was no independentRegulator to whom it could turn, legal action through the courtsbeing its only line of defence.

IBM (2006) reports the number of staffs engaged in regulatoryactivities related to the duties of the Regulator under Directive2001/14. Only Britain and Germany have substantial numbers ofstaffs devoted to economic regulation of rail services, and in Britainthe actual number of staffs involved is very much greater thanthose identified in the report as specifically involved in imple-mentation of Directive 2001/14. In several cases under the Ministrymodel the reported number is 0. It appears that a number ofcountries have simply designated the Ministry to be the responsibleauthority but with ad hoc arrangements to hear complaints (or

France Sweden GermanyBelgium Switzerland AustriaDenmark Czech Republic ItalyEstonia Hungary BritainHungary Poland LatviaGreece Portugal NetherlandsFinland SlovakiaIrelandLithuaniaLuxembourgNorwaySloveniaSpain

C. Nash / Research in Transportation Economics 22 (2008) 61–7066

even no arrangements at all!). Of course it may be that there is littlework for a Regulator in terms of hearing complaints in a countrywhere there is still a monopoly operator and no attempt at newentry. Where the Regulator is proactive in developing pricing andslot allocation mechanisms then obviously a more substantial staffis needed.

In both Sweden and Germany the regulatory arrangements haverecently been revised, in Sweden in the form of a strengthenedSwedish Rail Authority and in Germany with the transfer ofregulation from a railway authority, the Federal Railway Office, toa Regulator responsible for all public utilities, the Federal NetworkAgency. IBM (2006) concludes that Britain, Germany and Austriaare the countries that most completely fulfil its criteria in terms ofits regulatory arrangements. Of Sweden, it is said that it ‘seems tohave the necessary organisational structures’, but of France that itseems ‘doubtful whether the duties specified by European law canbe performed effectively.’

Table 6Rail infrastructure charges

Charging principle Basis of charges Differentiation

Britain MC (þ fixed chargesfor franchisees)

Vehicle km Vehicle characteristics, route

Sweden MC Gross tonne km Passenger, freightGermany FC Train km Type of path, train and

infrastructureFrance MCþ Fixed charge Type of path, train, time

of day, type of infrastructurePath kmTrain km

Source: Adapted from ECMT (2005).

7. Infrastructure charges

Directive 2001/14, on allocation of railway infrastructurecapacity and levying of charges, implements the proposals oninfrastructure charging put forward in the 1998 White Paper (CEC,1998). In summary, the directive determines that charges must bebased on ‘costs directly incurred as a result of operating the trainservice’. They may include:

� Charges for scarcity, although where a section of track isdefined as having a scarcity problem, the infrastructuremanager must examine proposals to relieve that scarcity, andundertake 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.� Non-discriminatory mark-ups but these must not exclude

segments of traffic which could cover direct cost.

Explicit time-limited subsidies are permitted to compensate fora failure to charge fully for costs on other modes.

ECMT (2005) points out three possible charging approachesfollowed by governments:

� Social Marginal Cost pricing (SMC), with state compensationfor the difference between the revenue this brings and totalfinancial cost. This yields the most efficient use of theinfrastructure, but puts the most pressure on state budgets andgives no incentive for efficient development of the network.� Full Financial Cost minus subsidies (FC�): setting access

charges to collect the difference between state compensationand full financial cost. This protects the financial state of theinfrastructure manager but may lead to inefficient use of theinfrastructure.� Mark-ups to Social Marginal Cost (MCþ): applying mark-ups to

social marginal cost in order to reduce or eliminate necessarystate compensation could yield the best trade-off betweenefficiency goals and the budgetary needs. MCþ pricing may befully consistent with FC�, but in practice countries using FC�tend to share costs between operators on formulae not basedon marginal cost.

In practice, charges are either:

� Simple tariffs: vary directly with the use of the network, bygross tonne km, train km, etc.� Two-part tariffs: where one part is variable with use and one

part is fixed.

Table 6 illustrates the principles behind the pricing structureand levels of rail infrastructure charges in our sample of countries.MCþ pricing is the most common approach in Western Europe,with levels of cost recovery ranging from 5% in Sweden to 63% inFrance (Fig. 1). Most countries using this approach charge for atleast part of maintenance and renewal costs, but Italy is unique inthe sense that maintenance and renewal costs are not charged forbut only traffic management is. Germany is the sole advocate of fullcost pricing in Western Europe, although in practice cost coverageis only 60% (capital costs are generally covered by the government).The full cost approach is widely followed in Eastern Europe, withthe Baltic States, Hungary, Poland and Slovakia adopting it with costrecovery ranging from 50% to 100% and Slovenia regarding it asa target, although it only covered 9% of costs from charges in 2004(ECMT, 2005).

At privatisation Great Britain also sought to cover full cost butmainly by the use of two-part tariffs, with the variable element ofthe tariff reflecting short run marginal cost. The situation now inGreat Britain is that two-part tariffs still exist for franchisedpassenger services (the majority) while open access passenger andfreight operators pay marginal cost. Charges have not beenincreased to cover the big increase in costs following the seriousaccident at Hatfield, however, and a direct grant from governmentto the infrastructure manager now covers around half the costs.

The result of the variety of approaches is different levels ofcharges (Fig. 2). Most countries have infrastructure chargingschemes broadly conforming to EU principles although:

� Some countries (e.g. Sweden) fail to charge for acceleratedrenewals and may actually charge less than marginal cost. Italydoes not charge for maintenance or renewals.� Some countries (e.g. Germany and some of the new members

e.g. Poland) appear to base their charges more on average thanmarginal costs.� Variation in the level of mark-ups means that actual average

charges vary from less than 0.5 to nearly 9 euros per train km.

A review of the situation by a task force brought together byDGTREN concluded that, provided that two-part tariffs (which poseobvious problems for operators running through a number ofcountries and having to pay the fixed charge in each) were avoided,the big problem was not the diversity of approaches but that thehigh charges in some countries damaged rail freight not only inthose countries but also on international routes involving them.Moreover, to the extent that high freight charges are used tosupport large networks required for passenger services there isa substantial element of cross subsidy involved.

0

10

20

30

40

50

60

70

80

90

100

N S NL SI SF I B DK P A CH SK UK RO CZ D F BG H PL EE LT LV

%

Fig. 1. Cost recovery from rail infrastructure charges, 2005. Source: ECMT (2005).

C. Nash / Research in Transportation Economics 22 (2008) 61–70 67

As noted above, there remains an argument that charges basedsolely on short run marginal cost, with or without mark-ups, do notprovide appropriate signals for the development of the networkeither to operators or to the infrastructure manager. Operators mayargue for enhancements to the infrastructure for which they willnot have to pay. Infrastructure managers may have an incentive tolimit capacity in order to profit from high congestion and scarcitycharges (there is some protection against this in the EU legislation,which requires a capacity enhancement plan to be tested wherevera scarcity charge is levied. In practice, scarcity charges are currentlyrare).

To the extent that infrastructure managers are governmentorganisations following social cost–benefit principles, the problemmay be reduced, although of course there is the usual principle-agent problem that they may seek to pursue their own objectivesrather than those of the government. However, a particular issuealso arises when regional passenger services are funded by a levelof government other than that responsible for the nationalinfrastructure manager. The allocation of infrastructure costs to theregions then becomes important; if the regions are only chargedthe marginal cost of actual train movements, they will have anincentive to demand excessive quantities and quality of trackcapacity. The solution would seem to be a two-part tariff, in whicha fixed charge is levied to cover the avoidable cost of the set ofservices in question, including the full cost of any track, signallingor other installation required solely because of the presence ofthese services. This fixed charge would be set at the time thefranchise agreement was made for the whole period in question,but might be negotiable if a change in service levels meant that theavoidable cost was to change substantially.

0

1

2

3

4

5

6

7

8

9

S N NL F B P CH I SI D SF DK

Freight trainsPassenger trains

Fig. 2. Typical rail infrastructure charges, 2005

A two-part tariff of this sort already exists in Britain, but thefixed element includes not just avoidable cost but also allocatedjoint costs, so the information it provides is blurred. It does notseem that such a fixed charge should hamper competition for thefranchise provided that whoever wins the competition is chargedon the same basis, but it is problematic when open access operatorsare permitted to compete with the franchisee; in Britain at presentthey do not contribute to the fixed cost, although there is anargument that they should pay to the extent that their entryreduces the surplus made by the existing operator (Baumol, 1983).

8. Assessment

The fundamental aims of the rail reform process in Europe wereto improve rail service quality and to reduce costs. In this section,we first look at trends in passenger mode share and in labourproductivity, before turning to the results of more formal cost andefficiency modelling for guidance.

Fig. 3 shows developments in terms of rail share of passengerkm for the three countries of greatest liberalisation (IBM/Kirchner,2004, 2006), Germany, Sweden and Britain, and for the EU15. Interms of passenger traffic the pattern for the EU15 as a whole is fora stable market share, in which rail traffic is growing as fast as themarket as a whole. Both Sweden and Britain have enjoyed a risingrail market share, whilst in Germany market share has fallen. Ofcourse, there are many factors which determine trends in traffic,but it remains interesting that the two countries which have gonefurthest in franchising rail passenger services have achieveda performance so far above the average in terms of passengermarket share.

A UK CZ BG RO H EE LT LV PL SK

(Euros per train km). Source: ECMT (2005).

9

8

7

6

5

4

3

2

1

01995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Passenger GermanyPassenger SwedenPassenger UKPassenger EU15

Rail Mode Share % Passenger Km

Fig. 3. Rail mode share (passenger).

C. Nash / Research in Transportation Economics 22 (2008) 61–7068

What of labour productivity? Table 7 shows the reduction inemployment in the national rail undertaking and the infrastructuremanager, and suggests that in the latter half of the 1990s Germanyoutstripped both Sweden and the European average; for Britain,where the data is for the infrastructure manager and passengeroperators only, reduction is slowest. However, it should be notedthat one important aspect of the German reform was to relieve DBof unnecessary staff and of excessive salaries and conditions causedby treating railways employees as Civil Servants (Kirchner, 2005).These actions do not depend on organisational structure. Moreover,the German reform had only just taken effect whereas the Swedishreform started much earlier. If we look at the years immediatelyfollowing the reform, and concentrate on train operations only, wecan make comparisons between all three countries (Table 8) for theperiod directly following reform. Here we find productivity growthto be fastest in Sweden; Germany achieved faster growth in trainkm per member of staff than Britain, but this was outweighed bythe faster growth in traffic per train km in Britain.

To what extent can more formal studies of rail restructuringshed light on the effects of rail reform. A whole series of studies(Cantos & Maudos, 2000; Cantos, Pastor, & Serrano, 1999; Gathon &Pestieau, 1995; Oum & Yu, 1994) have established that in the periodbefore the major reforms, those railways with greater autonomyand lower subsidies were the most efficient in terms of cost andproductivity.

On the issue of whether to break up existing railway companiesinto smaller ones, Preston (1996) found that the optimal size fora vertically integrated railway was that of one of the medium sizedEuropean companies such as Norway or Belgium. It appeared thatsplitting the larger European national companies into severalseparate companies might be worthwhile. By contrast, the British

Table 7Rail labour

Total staff % reduction(1995–1999)

Germany 34Sweden 17Britain 12EU15* 21

*1995–2000.Source: CEC (2006), except for Britain, which is for passenger operators and theinfrastructure manager only. This data was provided by Andrew Smith based oncompany accounts and refers to the financial years 1995/1996 to 1999/2000.

approach of splitting passenger train operations between 25 trainoperating companies would lead to much smaller companies thanappeared optimal; however, this result was based entirely onvertically integrated companies, so the implications for separateinfrastructure and operating companies of such splits are unclear. Alater study by Cowie (2002) examines the British train operatingcompanies, and concludes that they all do indeed have unrealisedeconomies of scale, so purely in terms of costs a smaller number oflarger companies would be preferable.

On the issue of vertical separation, Cantos et al. (1999), usingdata envelopment analysis on data for a sample of 17 Europeanrailways from 1970 to 1995, find that technical change increases inthe period 1985–1995 compared with earlier periods and attributethis partly to rail reform. But in this period the only countries toundertake vertical separation were Sweden in 1988 and GreatBritain in 1994, so as general evidence on the impacts of verticalseparation this evidence cannot be taken as strong. Certainly,Sweden is singled out as having improved its already-goodperformance significantly post 1988, and – whilst there may beother causes, including competitive tendering of passenger servicesand open access for freight – its success may indicate that a packageof measures including vertical separation may be a success.

Several papers (e.g. Bitzan, 2003) have attempted to estimatethe increase in costs from vertical separation using U.S. data, whichrelates entirely to vertically integrated railways. They do this byestimating a cost or production function in which both in-frastructure services and train operations appear as outputs. Theythen calculate costs for a company producing no infrastructureservices and for a company producing no train services and addthem. The flaw in this procedure is that it does not allow for theexistence of other organisations producing these services; in the US

Table 8Analysis of reforms in three European countries (annual average rate of growth in %)

Pre reform Post reform

Train km/train operating staffGermany 3.98 5.73Great Britain �0.55 3.96Sweden 0.45 10.15

Traffic units/train operating staffGermany 3.69 5.71Great Britain �3.48 6.18Sweden 2.58 10.63

Source: Rivera-Trujillo (2004).

C. Nash / Research in Transportation Economics 22 (2008) 61–70 69

a company producing low levels of infrastructure services is simplyneglecting its infrastructure, and it is not surprising that this leadsto higher train operating costs.

Cantos (2001) found interrelationships between the marginalcost of passenger and freight services and the value ofinfrastructure capital. Rather curiously, whilst an increase ininfrastructure capital reduced the marginal cost of freight services,it appeared to increase those of passenger. But in any event, thisfinding of an interdependence is itself hardly surprising and doesnot shed any light on whether these operations are best performedby the same or separate companies, although it certainly showsthat if separation is the approach adopted then contractualrelationships must be in place which give each party appropriateincentives in the light of these interrelationships.

Four recent studies have attempted econometric estimation ofthe impacts of separation of infrastructure from operations and ofopen access. The first is Friebel, Ivaldi, and Vibes (2003). This studyuses a production function approach to examine the effect ofreforms on rail efficiency. The three reforms considered are sepa-ration of infrastructure from operations, independent regulationand introduction of competition. The findings indicate that in-troducing any of the reforms individually or sequentially improvesefficiency, whilst introducing them as a package is neutral in termsof efficiency. This result is somewhat puzzling, but may indicate theimportance of at least undertaking some reform whilst suggestingthat trying to do too much simultaneously is not beneficial.

However, the study has severe data limitations. Firstly, it usesthe date when legislative changes formally occurred to indicatereforms; thus for instance Spain and France are supposed to haveintroduced third party access in 1995 and 1997, respectively,although in practice entry remained blocked. Portugal is shown ashaving independent regulation, although the only competition isfor a single franchise.

Moreover, the estimated production function is Cobb Douglasand the only inputs considered are staff and route km; the outputsare passenger and freight tonne km. Data for the UK is onlyavailable up to 1995, and the immediate effect of the reformpackage was to worsen efficiency. In practice, competition for themarket through franchising, which is much more significant thanopen access – which only occurred in the freight market – camelater. Other studies (Pollitt & Smith, 2002) conclude that thereforms in Britain did accelerate productivity growth, until thedramatic changes triggered by the Hatfield accident in 2000 (anaccident attributed to a broken rail led to major speed restrictionsand increased spending on infrastructure that culminated in thebankruptcy of Railtrack, the infrastructure manager). But when theUK is excluded, as it is from most of the analysis, institutionalseparation of infrastructure from operations (as opposed toorganisational separation within a single company) is found to havea positive effect on efficiency.

Copenhagen Economics (2004) use the same data with the sameproblems to examine the impact of market opening on prices andproductivity. They conclude rather surprisingly that in thepassenger sector, whilst market opening tends to reduce prices,slow market opening has greater benefits than fast. However, giventhat market opening is predominantly in the form of competitivetendering with government agencies responsible for setting prices,the significance of this result is unclear. They also find that a lowermarket share of the incumbent tends to reduce productivity whilstmergers raise it. This seems to suggest that market opening whichleads to fragmentation loses economies of scale.

The third study is Rivera-Trujillo (2004). This uses a moresophisticated translog production function with staff, rolling stockand track as inputs and includes Great Britain throughout.However, it is confined to traffic staff, thus excluding infrastructure;moreover, he stresses that there are some doubts about the

consistency of the data series in that the division between trafficand infrastructure is likely to differ between countries and mayeven change at the time of restructuring.

Rivera-Trujillo introduces dummy variables for separation ofinfrastructure from operations and for the introduction of compe-tition, representing the year in which these reforms actually tookeffect. He finds a significant positive effect on efficiency from theintroduction of competition and a significant negative effect forseparation of infrastructure from operations. The size of the twoeffects appears similar; however, the two variables are quite highlycorrelated. Excluding either one leaves the sign of the otherunchanged but substantially changes the magnitude of theparameter. Taken at face value, this result suggests that separatinginfrastructure from operations makes train operations less efficient,unless it is necessary for the introduction of competition, and eventhen it is doubtful whether the overall effect is beneficial. However,in the period in question, open access competition was generally ona very small scale. Moreover, for passenger services it seems likelythat it is franchising that is the more effective way of introducingcompetition, and the impact of this in most countries was limitedover the period in question. Thus the ultimate benefits of allowingaccess to the infrastructure to new operators may be substantiallyunderstated, and the benefits of achieving this worth the costs ofvertical separation unless those benefits can be achieved simply byrequiring access to the network without vertical separation.Whether it is possible, through independent regulation, to ensurecompetitive access to infrastructure controlled by the incumbentoperator seems doubtful.

The fourth study (Crowitsch & Wetzel, 2006) uses the DataEnvelopment Analysis approach to compare operating costs andlabour productivity for firms with integrated production and withvertical separation. It is concluded that vertically integrated firmsrequire around 9% fewer inputs and achieve 40% lower costs thanvertically separated ones. However, many factors which influencecosts, such as geography and the nature of the traffic, are notaccounted for in the study; moreover, it is also possible that differentstructures are associated with different degrees of contracting out.

Thus there remain great difficulties in gaining conclusive evi-dence in this field. Nevertheless, the evidence seems to be pointingtowards the conclusion that, typically, vertically integrated firmsachieve cost economies compared with vertically separated ones.Whether this is sufficient to offset any disadvantages in terms ofachieving effective intra-modal competition remains unclear. Thusfurther research on this issue is urgently needed to inform policy,although the difficulty of getting consistent data on the fragmentedrail systems of Europe is a major obstacle.

9. Conclusions

We have seen above that European rail policy has beenimplemented in a number of different ways and implemented atdifferent speeds. There are essentially three different models to befound; complete separation of infrastructure from operations,separation of key powers and a holding company structure. Thesedifferent models may be associated with differing degrees ofmarket access, both through open access and competitive tender-ing. Only in Britain, Sweden and Estonia is there no longer a singledominant state-owned train operating company.

Secondly, the small amount of experience of open access in thepassenger sector suggests that this has limited prospects; the lackof commercial opportunities and the barriers to entry posed byexisting integrated networks appear to offer limited scope for thisway of introducing competition. By contrast franchising appearsmore successful, although there remain significant problems toovercome in designing effective franchising regimes includingdealing with unrealistic bids and providing appropriate incentives.

C. Nash / Research in Transportation Economics 22 (2008) 61–7070

But finally what of separation of infrastructure from operations?Those countries which have completely separated them seem byand large to have been most successful in introducing competition,but it is likely that this comes at a cost in terms of transaction costs.These may be avoided by maintaining a vertically integratedcompany but only as long as that company remains dominant asa train operator, and at the expense of making the achievement ofa level playing field for competitors more difficult. It seems doubtfulwhether a combination of effective regulation, open access,competitive tendering and continuation of a countrywide verticallyintegrated state-owned holding company offers an effective alter-native to complete separation, particularly as the benefits of verticalintegration depend on the vertically integrated operator remainingdominant. Maintaining integration by leasing the infrastructure tothe main franchisee on each section of the network seems to offerbetter prospects, but it introduces a new set of interfaces betweeninfrastructure managers in different regions as well as leading toa situation which may favour the passenger operator over freight. Itis likely to work best where a set of relatively self-containedpassenger franchises can be defined and where freight and openaccess passenger operations are relatively unimportant. Thereseems to be no simple solution; rather there are trade-offs whichare likely to lead to different outcomes according to the circum-stances. Certainly this is an area in need of more research.

Acknowledgement

I wish to thank participants in Thredbo 10, and also an anony-mous referee, for their helpful comments. Responsibility for thefinal paper is, of course, solely my own.

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