Scale and network economies in transportation industries

Box 2. Scale and network economies in transportation industries

Economies of scale in transportation industries manifest themselves in a variety of different ways:

– Economies of fill due to operation fixed costs. They result from indivisibilities in vehicle operations, and imply that marginal costs of additional seats or passengers on an aircraft or train are negligible.

– Economies of hauling due to tracking fixed costs. These are a specific form of fill-economies absent in air but important in rail transportation and result from decreasing costs of adding capacity to an individual hauling operation. The engine power, energy and crew necessary for a longer and heavier train are not commensurate with the additional wagons which have been added (a train of 40 and a train of 60 wagons have similar trackage costs).

– Economies of density due to route fixed costs. They derive from route-specific infrastructure indivisibilities (such as terminal, track, and route mainte- nance fixed costs) and generate decreasing costs for adding new services/ new capacity on existing routes.

– Economies of stage length due to terminal fixed costs. Constant departure and arrival costs generate decreasing costs per distance of operation. These result from the high fixed costs of fuel for take-offs and landings, fixed airport charges, fixed air traffic control charges, and the immobilisation costs of aircraft and crew on route-ends.

– Economies of network reach due to network fixed costs. They result from the constant costs of operating a network, such as logistics, planning and management investments, and generate decreasing costs for servicing additional points.

OECD Economic Studies No. 32, 2001/I

The findings pointing to the sustainability of competition in certain segments of the transportation industry have been instrumental in creating consensus for transportation reforms more generally, including air transport, 44 initially in the United States and then in the United Kingdom, Continental Europe and other countries. Table 5 reviews the five most far-reaching transportation reforms in OECD countries during the past two decades, together with their renewed economic assumptions and objectives. 45

Most OECD countries have initiated reforms in the air sector, albeit mainly on

a domestic and regional basis only. International aviation routes remain regulated by a web of bilateral air agreements, which impose different regulatory rules by route, governing entries, route access, capacity and fares. 46 Even more liberal Open Sky agreements constrain the entry of third-party carriers, prohibit the continuation of international flights into domestic routes, and limit ownership changes. The uneven liberalisation of domestic-regional and bilateral- international markets is an important characteristic of the air sector.

In railways, reforms have been limited and concerned mainly the freight business. Some countries, notably the United States and the United Kingdom have significantly liberalised access of infrastructures to multiple providers (the starting reform initiatives at the EU level are discussed below). Transportation reforms have raised new regulatory issues, often because inherited infrastructures have proven inadequate and have failed to adapt to the requirements of new entries and service competition.

The traditional vertical organisation of the regulated transport industry took two forms: railway infrastructures follow a pattern of vertical integration with public-owned or regulated private service companies; airports are usually govern- ment facilities providing access to public-owned or regulated private service companies through long-term arrangements with their governing agencies. In either case, major investment decisions are taken and funded as central or local government policy decisions, and infrastructure supply was rarely a fully self- financing activity. This inherited institutional setting often resulted in a mismatch between the supply and demand of infrastructures after regulatory reforms had been implemented. Incumbents and new entrants had no formal assurance of access to the required types of infrastructures at economic prices. In order to alleviate the resulting bottlenecks, additional regulatory reforms have aimed at encouraging the adjustment of capacity to demand and its allocation to most efficient users, while at the same time preventing the use of market power and the distortion of competition in downstream services (Morrison and Winston, 1989; Meyer and Menzies, 1999). These regulatory issues are addressed below by

The Implementation and the Effects of Regulatory Reform: Past Experience and Current Issues

Table 5. Five main transportation regulatory reforms in OECD countries

Description of reforms

Economic fundamentals (assumptions and objectives)

Observed impacts

US Air reform, Full liberalisation of entries No risk of natural monopoly, Many new entries, 1978-1981

and fares in domestic air

differentiation of fares routes.

no risk of destructive

capacity and price

according to service class,

competition in the main

overall decrease of travel

domestic air routes.

costs, hub-and-spoke reorganisation of networks. Subsequent market consolidation and lesser fare decreases in hub-dominated routes.

US Rail reform, Full liberalisation of entries Services are potentially Rail passenger 1982

and fares in domestic rail competitive, infrastructures transportation shrunk routes. Integrated

radically: only one (infrastructure/operation)

are natural local

government-owned carrier companies give open

monopolies to be opened

remained in operation. access to competitors.

to competitors under

regulation. Services

Rail freight services strongly

are commercially

grew in certain markets,

sustainable if socially

declined in others,

valuable – or otherwise

and consolidated into

decline.

a more concentrated market structure.

UK Rail reform, Privatisation of railtrack

120 new railway companies 1993

Service markets

infrastructure as a regulated are not potentially (20 main passenger service monopoly, passenger

companies) were formed. services franchised

competitive but can

Fares and productivity for 8 years to private

be open to challenge

increased according bidders.

through periodical bids.

Infrastructure is a regulated to terms of franchising natural monopoly which

contracts, often giving rise

can be developed without

to larger-than-anticipated

vertical links to services.

profits, provoking renegotiations with the regulator. Contracts between rail players (between infrastructure and services) are also being redesigned.

EU Air reform, Full liberalisation of entries European air service Certain fare decreases 1993-1997

and fares in intra-European markets are potentially and new entries on certain air routes, for “community

routes, but to a much lesser carriers”.

competitive, supply

rationalisation can develop extent than anticipated. in the European internal

Airport slot bottlenecks

market.

constrained entries, and existing bilateral agreements (with non-EU countries) have constrained network optimisation.

OECD Economic Studies No. 32, 2001/I

Table 5. Five main transportation regulatory reforms in OECD countries (cont.)

Description of reforms

Economic fundamentals (assumptions and objectives)

Observed impacts

International Bilateral liberalisation

Significant capacity “Open Sky”

Main international air

increases and fare Air Agreements, governments, allowing

agreements between

routes are potentially

decreases on bilateral 1991-1999

competitive,

routes. Market carriers, capacity and fare

designation of multiple

and competition can

concentration and alliances freedoms, and traffic rights

develop without open

limited these price to third-countries.

access to domestic

movements. Source:

(cabotage) routes.

OECD Secretariat.