Why to Invest in Rolling Stock when Future Industry Structure is Uncertain? (The Case of Railway Reform in Russia)

Why to Invest in Rolling Stock when Future Industry Structure is Uncertain? (The Case of Railway Reform in Russia)


A Dementiev, Higher School of Economics, RU


The paper analyzes the impact of institutional and price uncertainty on the firms' investment decisions during the railway reform in Russia to assess first results of an open-access model and derive policy recommendations about future reform steps


Problem statement and background

The first seven years of railway reform in Russia have demonstrated a solid progress so far, especially in the freight sector. The three-stage reform plan called for: 1) opening rail infrastructure for access by private non-integrated operators (like in Germany); 2) developing competition in the downstream market (operations); 3) promoting private investment in freight wagons and (possibly) locomotives. The infrastructure owner - Russian Railways JSC (or RZD) - encouraged the establishment of new operators competing with its' downstream affiliate and welcomed investment in rolling stock since it faced the shortage of wagons coupled with the lack its own sources for investment. As a result about RUR 80 billion have been invested in private freight wagons during the first four years of reform. The traffic share (in tons) generated by dozens of private operators have increased from 27.2% in 2003 to 33.8% in 2005. It is expected that more than half of the wagon fleet will be owned by private companies within the next few years.
The adopted reform measures have opened the room for on-track competition to emerge firstly in the most lucrative markets (eg. transportation of oil and high value-added commodities) where open access operators grabbed up to 70% of ton km on particular routs benefiting from the oil price shock.
In 2007 the government adopted the 'target model' for railroad industry and allowed RZD to establish its' daughter company - the First Freight Company (FFC). Thus the competitive environment in the industry has been reshaped. Noteworthy, the initial (adopted in 2001) reform plan left for later decision the possibility for divesting vertically integrated RZD (for instance in the form of creating and privatizing the fully deregulated downstream affiliate). At the stage when major investment decisions by private operators were made (2003-2006) the future industry structure remained uncertain.
It is envisaged now that in the mid-term FFC will be partially privatized through IPO though the exact share structure is still unknown. In terms of vertical integration the future de facto industry structure still remains questionable (especially, if we take into account the incentives to preserve some informal relations between RZD and FFC). Thus the question of optimal railroad industry structure in Russia requires both theoretical and empirical study and deserves some research efforts.

Research hypotheses

In the presence of uncertainty about the future structure of vertically integrated industry the non-integrated rival will invest more in capacities the lower is the probability of vertical divestiture when it competes with RZD in prices given the precommited rolling stock capacities. The vertically integrated industry structure may be compared favorably towards the vertically separated one in terms of welfare even when RZD can raise rivals costs to undermine their competitiveness (thus resorting to some discriminative activities that can not be perfectly monitored by the regulator).

Description of data

Our empirical analysis relies on the original set of data on investment in different types of freight rolling stock during the first years of railway reform in Russia. The data set covers about 2200 private wagon owners classified by the type of wagon. We also use data on production and import of railway rolling stock in Russia available for the period of 1999-2005.

Expected results and implications

The analytical framework we develop is designed to model the 'without a map' approach to railway reform in Russia. We attempt to capture the basic stylized facts of the reform to fuel the debate about the optimal future structure of the industry.
We expect the paper to show the optimal investment and pricing strategies for both RZD and its rivals taking into account the future possibility of railroad industry restructuring. The important sub-question that we try to emphasize is whether underinvestment problem will take place in equilibrium.
We also address the problem of optimal structure of vertically related industry with price-setting firms competing downstream and having their capacities constrained. At this stage of research we do not endogenize the firms' incentives to vertically disintegrate or integrate leaving this structural decision to the regulator. Rather, our focus is primarily on endogenous choice of capacity levels in the absence of full information about future industry structure and, consequently, the nature of competitive environment.
The model can be utilized as a conceptual framework for the policy analysis in Russia and other countries dealing with restructuring of railroad industries.


Association for European Transport