Structural reforms in the railways: Incentive misalignment and cost implications

In Europe, many countries have completely separated their railways into totally separate infrastructure managers and railway undertakings (train operators) and the European Commission has sought to make such complete vertical separation a legal requirement. This study used both quantitative and qualitative methods to investigate the impact on costs of vertical separation. We find the impact to vary with circumstances, but for more densely used railways and those with a higher proportion of freight traffic, vertical separation raises costs. It appears that the main reason for this is the misalignment of incentives, leading each player to seek to optimise their own costs rather than those of the system as a whole. Various approaches are used to try to overcome this misalignment, through track access charges, performance regimes and various forms of partnership, but none is fully successful. We also find no evidence that complete vertical separation leads to more competition, or indeed that such an increase in competition reduces costs, though we consider that further work is needed to better measure the extent of competition in different markets. From a policy perspective our findings suggest that alternative railway structures will suit different railways with different patterns of usage and therefore a policy that seeks to impose complete vertical separation on all EU members would increase costs