An Evaluation of the Draft Access Pricing

Principles for Access to the Victorian Rail

Network (Freight)
A Report Prepared on Behalf of Freight Australia Ltd

by

Joshua S. Gans
University of Melbourne

28 th June, 2000
 Executive Summary
This paper evaluates the proposed access pricing arrangements for the Victorian rail
network. Those arrangements are a form of average cost pricing but without any
allowance for assets already in existence.

In terms of efficiency, while such pricing can promote downstream competition it is

likely to create allocative, productive and, most importantly, dynamic inefficiencies
that will likely outweigh any overall competitive benefit. In particular,

• Simple average cost pricing per gross tonne km is likely to give rise to allocative
inefficiencies because it takes no account of demand-side information or the
technological characteristics determining the relationship between costs and
weight multiplied by distance. The end result will be that the rail network is
inefficiently utilised with consumers with relatively elastic demand not gaining
sufficiently from increased competitive pressure perhaps to the extent of facing
higher rather than lower prices.

• The proposed access pricing arrangement is unlikely to achieve long-term

productive efficiency especially to the extent that it is successful in placing large
downstream competitive pressure on the incumbent rail operator. This is because
the pricing mechanism is purely cost-based offering few transparent incentives for
the network operator to direct efforts toward cost-reduction.

• The proposed access-pricing regime for the Victorian rail network is likely to be
highly inefficient from a dynamic perspective. It provides incentives for
distortionary expenditures on new capital while sending a signal to potential
infrastructure operators in Victoria that they will be unlikely to earn rates of
return commensurate with the social value of those investments. Given such
regulatory risks, new infrastructure investment and the purchase or lease of
privatised assets in Victoria are likely to be delayed and potentially curtailed
altogether.

It is demonstrated that such access pricing is not practiced for rail in Australia or in
other countries. Based on experience elsewhere and on economic theories of efficient
access pricing, it is concluded that a preferred pricing outcome would be to impose a
multi-part tariff with:

• Usage charges that reflect an appropriate unit of the service, likely to be

contingent on the type of freight, as well as be a price cap rather than a cost-plus
price.

• A fixed charge that is designed so as to facilitate the efficient recovery of

investment costs utilising demand-side information to reflect a downstream
 access seeker’s value on access as well as incentives to prevent by-pass or cream
skimming.
In this way, a transparent pricing commitment could be made by the regulators to
facilitate negotiations over access while preserving overall economic efficiency.
Contents Page

1 Background.............................................................................2

2 Efficiency Implications of Proposed Access Pricing

Regime......................................................................................4
2.1 Allocative Efficiency...................................................... 6

2.2 Productive Efficiency ....................................................11

2.3 Dynamic Efficiency.......................................................13

2.4 Negotiations..................................................................19

3 Other Rail Access Pricing Regimes ..................................21

3.1 Australia........................................................................21

3.2 International..................................................................23

4 Towards a More Efficient Pricing Structure ...................24

4.1 Taking into Account Investment Costs ........................24

4.2 Incentives for Cost Reduction.......................................26

4.3 Consistency and Transparency.....................................27

5 Conclusions ...........................................................................28

6 Tables: Approaches to Freight Rail Access Pricing .......29

6.1 Australian Approaches .................................................29

6.2 International Approaches .............................................30

Attachment A: Recent Research....................................................32

Attachment B: Consultant Profile.................................................34

June 2000 i
1 Background

In April, 2000, the Victorian Government proposed to declare the

Victorian rail network used for freight purposes. This would give
potential access seekers – people or firms wishing to haul freight on the
rail network – the right to gain access on terms that would be negotiated
between those seekers and Freight Australia, who currently leases the rail
network from the Director of Public Transport.1 This proposed declaration
will arise under Part 2A of the Rail Corporations Act 1996. That Act gives
the Office of the Regulator-General (ORG) the role of arbiter in any
disputes between Freight Australia and access seekers.

As part of the declaration process both the ORG and the Victorian
Department of Infrastructure have issued draft access pricing guidelines
that will form that basis of arbitrated outcomes.2 The key characteristics of
the proposed pricing regime are:

• Simple pricing per gross-tonne-kilometre used by the access

seeker (including a flagfall charge);

• Price is based on a measure of variable costs for a line, that is,

operations and maintenance costs (plus a 10% margin), plus new
capital expenditure associated with that line and a rate of return
on that new expenditure;

• Adjustments are made to the cost-base where passenger services

also run on a line. In particular, on the metropolitan network
which is primarily passenger based, freight operators will be
responsible for incremental costs only (except for peak periods).
On the country-network, account will be made for passenger
traffic although a disproportionate share of all costs will fall on

1 Who in turn has leased it from VicTrack (a Victorian government statutory authority).

2 “Proposals for Implementation of the Victorian Rail Access Regime,” Department of Infrastructure,
Victoria, April 2000 and “Victorian Rail Access Regulation – Discussion Paper,” Office of the Regulator-
General, Victoria, 19 April 2000.
Section 1 Background

freight traffic even though passenger traffic will receive

scheduling priority.

An important feature of this proposed pricing regime is that there is no

allowance for previous investments in the rail network. These costs were
considered ‘sunk’ and hence, the government was of the view that no rate
of return would be required on these. This included any rental payments
for the operation of that network. However, this principle was not applied
for the Dynon terminals where existing assets could be included in the
cost-base; including a factor for a rate of return earned by the access
provider.

Because charges are based on a ‘line service,’ some common costs

incurred over the entire network will have to be allocated to a line.
However, despite the desire for transparency and simplicity, no means of
allocating those costs is given in the guidelines save for the requirement
that such an allocation be “fair and reasonable.”3

This paper will review the proposed access pricing approach for
the Victorian rail network. The next section discusses the implications of
the proposed approach for the realisation of economic efficiency and
demonstrates that it is likely to fall short of goals attained for regulators in
other jurisdictions. Section 3 will then compare the proposed approach to
rail access regimes in other jurisdictions; finding the proposed approach
unique in its lack of attention to investment incentives and incentives for
cost-reduction. Section 4 will then propose some potential changes to the
proposed regime that would likely result in substantial efficiency
improvements. A final section concludes.

3 DOI, op.cit., p.51.

June 2000 3
Section 2 Efficiency Implications of Proposed Access Pricing Regime

2 Efficiency Implications of Proposed Access

Pricing Regime

Access regulation is a response to a particular competitive concern

that pervades many industries where infrastructure investment is heavy.
In effect, many networks – rail included – involve production technologies
that exhibit natural monopoly characteristics. This means that, from the
point of view of minimising the average production costs associated with
that networks’ services, it is preferable to have one, and only one,
network. Any more and the infrastructure costs associated with that
network are duplicated; imposing real resource costs on the economy. The
problem, however, is that where there exists a single network, there also
exists a single seller of network services and consequent problems
associated with monopoly supply.

The potential problems of monopoly supply are threefold:

• High prices: the prices charged by a monopolist for services rendered
may be too high and create so-called ‘dead-weight losses.’ These
losses arise because there are consumers who would be willing to
purchase an extra unit of the service at a price that exceeds the costs
associated with supplying that extra unit to them. Value would be
enhanced if that trade took place but the monopolist, fearful of
discounts to other customers, chooses not to lower price and expand
output. The possibility of price discrimination can alleviate this
problem but may exacerbate other problems associated with
monopoly.

• Cost and quality: in the absence of competitive pressure there is

concern that a monopolist may have insufficient incentives to invest
in cost-reduction or quality-enhancement. Of course, to the extent
that the monopolist can appropriate cost savings or quality
enhancements in the form of higher profits such concerns are
perhaps unfounded. Nonetheless, it is generally thought that the
absence of competitive pressure may lead to higher costs and lower
quality than would be socially desirable.

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Section 2 Efficiency Implications of Proposed Access Pricing Regime

• Vertical leverage: the final problem of monopoly is the ability of the

monopolist to use its market power to generate monopoly outcomes
in related markets; in particular, for a network, there is a concern
that the monopolist may use discriminatory pricing or vertical
integration to reduce the level of competition in downstream
markets.

Access regulation is, in the first instance, a means of addressing the final
problem here. That is, it guarantees access of downstream firms to the use
of the services of the network and also ensures that the pricing terms are
such as to preserve downstream competition. This prevents the leverage
of monopoly power to other markets. However, from the perspective of
overall efficiency, appropriate access regulation also plays a role in
reducing the efficiency losses associated with high monopoly pricing and
also ensuring that the cost and quality of network services are acceptable.

Of course, in evaluating the potential efficiency of access regulation

one also needs to be concerned about its impact on the network’s
decisions on variables that are not directly regulated. In the case of a rail
network key unregulated variables include the downstream pricing of the
vertically integrated rail operator as well as its decisions regarding new
investment, effort in cost-reduction and the quality of its service. These
variables either cannot be easily regulated or the informational burden on
regulators in ‘second-guessing’ the commercial decisions of a private firm
is too high. Indeed, the economic rationale for privatisation (or in this case
private control) of such networks lies predominantly in the fact that
efficiency would be enhanced if such variables were unregulated and, but
for some minimal requirements, determined by the profit-seeking
opportunity of the private owners. If those efficiencies were not expected
then perhaps it would be better to ‘regulate’ such networks by leaving
them in public hands without the profit-orientated incentives that would
otherwise direct their activities.4

Thus, access pricing cannot simply be determined with respect to

theoretically desirable pricing benchmarks as the precise means of
regulation may influence the network’s choices on other fronts. Those

4Stephen King and Rohan Pitchford, “Privatisation in Australia: Understanding the Incentives in Public and
Private Firms,” Australian Economic Review, 31 (4), 1998, pp.313-328.

June 2000 5
Section 2 Efficiency Implications of Proposed Access Pricing Regime

choices may impose additional efficiency costs on the industry.

Consequently, appropriate access regulation will take into account the
incentives provided on other variables under the control of the network
and adjust access pricing formulae accordingly.

From this perspective, one needs to evaluate a proposed access

pricing arrangement in terms of the overall achievement of economic
efficiency. Such efficiency can be divided into three components:
• Allocative Efficiency: the network’s assets should be used efficiently.
That is, where there exists a use for service for which the incremental
costs of that use are lower (higher) than the value placed on that use
by a network’s customer, the service should (should not) be supplied
to that customer.

• Productive Efficiency: the network should operate at the lowest

possible average cost.

• Dynamic Efficiency: improvements or expansion of the network

should only take place if the long-run value derived from those
investments exceeds the costs associated with that investment.

The proposed access pricing arrangement should be evaluated with

respect to the achievement (or non-achievement) of each of these
efficiency improvements. Each is dealt with in turn.

2.1 Allocative Efficiency

One of the goals of access regulation is to ensure that infrastructure

is put to its optimal use. This means that services are sold to customers
who value that service more than the marginal or incremental costs of
supplying that service to them. On the other hand, where marginal costs
outstrip a customer’s willingness-to-pay for the service, the service should
not be supplied to them.

In economics, the textbook pricing benchmark – that of setting price

equal to short-run marginal or incremental cost – is designed to achieve
optimal usage of a service. When price equals short-run marginal cost,
customers will only purchase that service if their willingness-to-pay

June 2000 6
Section 2 Efficiency Implications of Proposed Access Pricing Regime

exceeds that and not otherwise. What this means is that, in general, if
price does not equal short-run marginal cost, there will be losses in
allocative efficiency. For high prices, too few customers are supplied the
service and for low prices, too many. The latter can occur when there is
some form of subsidy to the service.

The proposed pricing arrangement for Victoria rail differs from this
pricing benchmark in two important ways. First, it is based on a form of
average, rather than marginal, cost pricing. Second, it is a charge based on
gross tonne kilometres that may not accurately reflect a ‘unit’ of freight
rail service. As will now be shown the neglect of each of these makes it
likely that outcomes achieved will be allocatively inefficient resulting in
sub-optimal usage of the network.

2.1.1 Average Cost Pricing

The incremental cost of supplying a service to a customer involves

those costs that would be avoided or saved if the service was not supplied.
This includes additional labour and energy devoted to servicing that
customer as well as an estimate of the wear and tear (and resulting
maintenance) that can be attributed to that customer.

In an access situation, also included with these cost would be costs

associated with providing access. These might include accounting and
contract settlement costs but would also include an allowance for
congested track in times of capacity shortages. Including the costs of
providing access as part of the cost-base in pricing was not explicitly
addressed in the proposed access-pricing regime although it is standard
practice in other jurisdictions and one would expect to see it come under
the cost allocation procedures.

In practice, with many different users of a service, estimating

incremental costs involves accounting for all of the variable costs of a
service as well as accounting for maintenance on the line and
apportioning it to different users based on the intensity of their use of the
service. These operations and maintenance costs are included in the cost-
base in the proposed pricing arrangements.

However, additional costs are included in that cost-base. First, the

network is allowed to earn a rate of return on operations and maintenance

June 2000 7
Section 2 Efficiency Implications of Proposed Access Pricing Regime

costs associated with a line. Second, new capital expenditure plus an

allowable rate of return on that also form part of the cost-base of the line.
Finally, common rail network costs that cannot be attributed to a given
line are allocated to lines on a yet-to-be-defined ‘fair and reasonable’ basis.
Each of these means that the price paid by access seekers to use a network
will exceed incremental costs. Hence, it may be under-utilised resulting in
a loss in allocative efficiency.

This is a common difficulty in regulation where it is required that a

rail network be allowed to break even. That is, new capital expenditure
and common costs need to be recovered by the access provider. This
means that some of these costs must be recovered from access seekers;
otherwise the provider would not break-even and could even shutdown.
Hence, allowing for the recovery of those costs will invariably mean that
per unit prices will exceed incremental costs.5

The problem, however, is that average cost pricing is a highly

inefficient way of recovering fixed costs associated with production. This
can be seen by observing the way a vertically integrated rail operator
chooses to price to freight haulers. It is invariably the case that different
customers pay differing rates depending on the type of freight hauled and
potentially on the distance hauled. In its pricing, the rail operator takes
into account the differing elasticities of demand for the rail service among
customers. A customer that relies exclusively on rail will have a higher
elasticity of demand relative to one that has the option of other modes of
transport (including road or sea). For example, compare bulk traffic to
containerised traffic. Hence, by charging the relatively inelastic customer a
higher price, the rail operator assists in raising profits; giving it a greater
opportunity to recover its fixed costs. It does this precisely because a high
price to the relatively inelastic customer will not cause it to reduce its use
of the rail services by as much as for the relatively elastic customer. In
other words, price discrimination allows the rail operator to increase
profits at the least distortion to allocative efficiency.

Similarly, the same principle should apply for the efficient recovery
of fixed costs in regulated pricing. That is, the least distortionary means of

5As will be discussed in Section 4 below this need not occur if the regulator encourages the use of non-linear
pricing such as a two-part tariff.

June 2000 8
Section 2 Efficiency Implications of Proposed Access Pricing Regime

allowing a regulated network to break-even is to price discriminate

among customers. This is the so-called Ramsey logic for regulated pricing.6
It is a relatively efficient means of regulated pricing because it utilises
demand-side information in addition to basing prices ultimately on
incremental costs.

The proposed pricing regime based on average cost pricing is likely to be

highly inefficient precisely because it neglects any demand-side considerations
that have proven to be very important in rail service pricing. What this
means for the operation of the network is that access seekers will have an
opportunity to engage in ‘cherry picking’ or ‘cream skimming.’7 That is,
when they face access charges based on average costs only, they will find
it profitable to service those customers that would be otherwise charged a
high price by the vertically integrated rail operator. This competition will
reduce the price received by relatively inelastic customers who are
dependent on rail services. This is obviously desirable for those
customers. However, it is also likely to raise the prices faced by relatively
elastic customers. This is because the rail operator’s incremental cost of
servicing those customers (to the extent that average costs on a line rise
with overall use) will rise. Hence, those customers will be worse off and,
will be the losers rather than the beneficiaries of competition.

However, the distortions associated with neglecting demand-side

considerations in pricing go further. In particular, the lack of specification
of the allocation of common network costs means that potentially costs
will be more likely to be allocated to those lines likely to be subjective to
competitive use. In some sense, given the distortions of average cost
pricing, this redresses some the cream skimming problems. It does this,
however, in a relatively inefficient and potentially damaging way.
Moreover, and more seriously, the distortions introduced may be real in
nature. The network management may direct their attention towards
services they operate with higher margins and away from competitive
segments. Once again, if the pricing regime gives incentives for cream

6See, for example, J-J. Laffont and Jean Tirole, Competition in Telecommunications, MIT Press: Cambridge
(MA), 1999.

7See Alfred Kahn, The Economics of Regulation: Principles of Institutions, vol. 2, New York: Wiley, 1971;
and J.-J. Laffont and Jean Tirole, The Theory of Incentives in Regulation and Procurement, MIT Press;
Cambridge (MA), 1993.

June 2000 9
Section 2 Efficiency Implications of Proposed Access Pricing Regime

skimming, one can expect the regulated network to use its accounting and
other choices to minimise that harm.

2.1.2 ‘Unit’ of the Service

The proposed access price is based on a per gross tonne kilometre

basis. Effectively, this means that a unit of the access service is weight
multiplied by distance. However, it is not entirely clear that the costs
associated with providing this service relate to this simple service
measure. This is, by definition, the case for fixed costs included but also
applies to variable costs where maintenance is more likely to depend on
weight compared with operations. However, both classes of costs are
treated equally.

The definition of a service is, of course, a difficult one. It may be

that for certain types of freight a gross tonne km basis is the best measure
available. However, one should look to the business practices of rail
operators in their pricing to final consumers to determine this. Here one
would likely find that the terms of offered to those consumers are highly
contingent on the type of traffic and distance travelled.8 In particular, the
overall price is not necessarily a simple, linear function of weight
multiplied by distance.

What this means is that if the unit for the access service differs from
that that would be appropriate to measure costs associated with that
service, further distortions are introduced. In particular, if as weight
increases, marginal maintenance costs rise, then access seekers will be able
to more easily attract ‘heavy’ haulage and a disproportionate share of
costs will end up being passed onto ‘light’ haulage. If marginal
maintenance costs are falling as weight rises, the opposite could occur.
This suggests that the regulators need to be very careful before specifying
a particular ‘unit’ of the service. As we will see in Section 3, gross tonne
km is not used as the basis for access pricing in all jurisdictions.

8 Indeed, these tensions are already apparent in the proposed access regime which changes the ‘unit’ for those
lines that operate passenger traffic.

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Section 2 Efficiency Implications of Proposed Access Pricing Regime

2.1.3 Summary

Simple average cost pricing per gross tonne km is likely to

give rise to allocative inefficiencies because it takes no
account of demand-side information or the technological
characteristics determining the relationship between costs
and weight multiplied by distance. The end result will be
that the rail network is inefficiently utilised with
consumers with relatively elastic demand not gaining
sufficiently from increased competitive pressure perhaps
to the extent of facing higher rather than lower prices.

2.2 Productive Efficiency

Particular forms of regulation can influence other variables under

the control of the regulated firm. One class of variables concerns the
efforts of the operators of a network towards ensuring the costs are as low
as possible and quality is maintained. However, the regulated price here is
exclusively cost-based. From an economist’s perspective this means that
the regulated firm will have low-powered incentives to contain costs and
maintain quality. Indeed, under the proposed access-pricing regime, the
more successful are potential entrants into its downstream activities the
lower will be its incentives to undertake these activities in a socially
desirable manner. The end-result will be that the rail network in Victoria
will be productively inefficient as costs will not be minimised and quality
may deteriorate. As mentioned earlier, this would undermine the precise
benefits privatisation was designed to generate.

There are two dimensions of the incentive problem that arises

when a cost-based pricing scheme is used: cost-reductions and cost
reporting. First, consider the case where the regulator can accurately
determine what the true costs are that form the basis of the price. In this
situation, every $1 achieved in cost reduction results in a $1 reduction in
price. Thus, the regulated firm’s incentive to engage in that cost reduction
relates not to the total level of rail traffic on a line (say Q) but only its own
proportion of that (say q). Thus, to the extent there are investments to
achieve that reduction in cost, the network’s reward for that reduction is
at best q for each dollar saved and may be worse if the reduction

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Section 2 Efficiency Implications of Proposed Access Pricing Regime

precipitates a more than proportionate increase in price competition

downstream.9 What this means is that the network operators incentives to
contain costs are lowest precisely on those lines that are subject to the
most competition and third-party access. Indeed, it is possible that costs
may be lower and fewer distortions may actually occur if there was no
access regulation. Thus, a lack of respective for incentives has the potential
to undermine the very gains, in terms of lower final service prices, that
access regulation was designed to promote.

Second, to the extent that the regulator cannot easily establish the
costs of the network, there is potential for a distortion of reported costs
upward. This has the harmful consequence of raising access prices and
potentially undermining the strength of downstream competition.
However, to the extent that it is easy to engage in ‘creative accounting,’
this does mean that the network will retain a greater share of actual cost
savings; thereby, mitigating some of the adverse incentive consequences
described above. At present, the proposed guidelines do allow for some
monitoring of costs but ultimately establishing actual costs will require an
adequate level of regulatory resources; imposing more real economic
costs.

As will be discussed in Section 4, concerns about the incentive

effects of cost-based regulated prices have caused regulators in many
jurisdictions and industries to move towards pricing mechanisms with
more preferable incentive properties.

A final consideration with respect to productive efficiency concerns

the lack of incentives given in the proposed pricing arrangements to
access seekers to ensure that their own wagons and traffic are operated
and maintained in a way that minimises wear and tear on the rail track
itself. While access arrangements can have minimal standards for access to
be granted, the pricing arrangements offer no means by which the
network operator can reward access seekers for car quality beyond these
minimal levels. Once again, the neglect of this is likely to exacerbate cost
and quality concerns and further damage the productive efficiency of the
rail industry in Victoria.

9Indeed, the rate of return allowed on all these costs – being a percentage of these costs – distorts incentives
away from cost-reduction and cost reporting even further.

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Section 2 Efficiency Implications of Proposed Access Pricing Regime

The proposed access pricing arrangement is unlikely to

achieve long-term productive efficiency especially to the
extent that it is successful in placing large downstream
competitive pressure on the incumbent rail operator. This
is because the pricing mechanism is purely cost-based
offering few transparent incentives for the network
operator to direct efforts toward cost-reduction.

2.3 Dynamic Efficiency

Perhaps the most important dimension of efficiency concerns the

impacts of the access-pricing regime on long-term incentives to invest in
new infrastructure. One of principal motivations for privatisation of
public utilities was to allow private market forces to determine new
investment decisions. Hence, in evaluating the impact of access regulation
on the rail network it is critical to consider what its impact will be on new
capital expenditure for that network but also on the signal it sends
regarding regulatory attitudes towards investment across all
infrastructure industries in Victoria.

2.3.1 New Rail Investment

New rail investment will be best undertaken when the value of

improved service – relief of congestion, long-term quality enhancements
etc. – exceed the investment costs associated with those improvements. In
an access context, value should be evaluated in terms of value to the
access provider and to access seekers. The proposed access regime makes
allowances for new investment and, indeed, will allow adjustments to the
access price when such investment takes place. This includes both line
specific investment, whose expenditures will be allocated through the
cost-base of the access price and network expenditures that will also be
allocated in part to particular lines; forming part of their cost-base.

The problem with this method of treating new investment is

precisely the same as the problem with the way all costs are dealt with
through the proposed pricing regime: they provide low-powered
incentives for the network to contain new capital expenditures. In
particular, the greater are these, the higher will be access prices and the

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Section 2 Efficiency Implications of Proposed Access Pricing Regime

lower will be the degree of downstream competition. Basically, new

capital expenditures impose an externality on access seekers through the
consequent adjustment to access prices and, as such, will likely mean that
such expenditures will be excessive from a social perspective. The source
of this difficulty is essentially to cost-based form of access pricing. As will
be argued in Section 4, these incentive difficulties could be remedied if the
regulator were to opt for a higher-powered incentive scheme as practiced
in other jurisdictions.

2.3.2 Investment Signals

The papers proposing the access-pricing regime for freight rail in

Victoria give scant attention to the rationale behind the chosen pricing
formula. However, the attitude to investment signalling is made very clear
by the following statement:

Much of the network was constructed decades ago and can be

regarded as a “sunk cost” for which no capital return is
required…. For the same reason no amount is allocated for rent or
other payments made by the Access Provider under its lease.10

As I will discuss here, this statement is incorrect as a matter of economics

and represents an extraordinary disregard for the principles of efficient
regulation. Basically, by not allowing the access provider to recover sunk
infrastructure expenditures through access pricing – leaving the provider
to rely solely on their own downstream activities – the regulator is
sending a signal to investors in infrastructure that they have a choice of
waiting for other potential providers to invest first and seek access from
them or alternatively to invest and find the value of assets created
expropriated by the Victorian regulator.

Almost all investments in infrastructure represent sunk costs, ex

post. Basically, the assets are dedicated to particular activities and often
have little scrap value. While it is consistent with economic efficiency to
neglect these sunk expenditures in determining the optimal use of an
asset, regulatory authorities cannot neglect them when it comes to the
potential for future investment. No firm would invest if it thought that,

10 DOI, op.cit., p.19.

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Section 2 Efficiency Implications of Proposed Access Pricing Regime

after the fact, they would be deemed sunk and no return would be
required. No financier would lend to a firm that believed this. All
investment takes place with a view to future return and the potential
irreversibility of investment decisions is a constraint that requires
potential investors to be even more secure in their expectations of
generating a return.11 So far from not requiring a return, the requirements
are in fact more stringent than for investments that were reversible and
whose expenditures were not sunk.

In an access setting, the consequences of a lack of respect for

investment incentives are profound. Put simply, potential investors would
rationally delay or refrain from any investments if they thought
investment costs would not form part of the cost-base for access pricing –
even where their own return would justify that investment. To see this,
consider the following hypothetical situation.
[I]magine that the Trade Practices Act mandated that the services
provided by all lawncutting devices were subject to an access
regime, in this case, for the production of neat gardens. The Smith
family is considering purchasing a lawnmower. However, before
they do this they notice that their neighbours, the Jones family,
have a nice new lawnmower. The Smiths propose to the Joneses
that perhaps they could borrow their mower for one day a week.
They argue that the loan would not inconvenience the Joneses
who use the lawnmower themselves for one day each week. Of
course, the Smiths will compensate the Joneses for fuel used and
physical depreciation caused. This offer is, of course, consistent
with the economically efficient use of the lawnmower. That is,
given that the lawnmower exists and is not fully utilised by the
Joneses (that is, there is excess capacity), if the Smiths are willing
to bear the costs of their usage, it is socially efficient for them to be
granted access to the Joneses’ mower. To the extent that there is a
legal stipulation for the Joneses to grant the Smiths access, so
much the better.

The problem, however, is that the Joneses were

considering purchasing an electric weeder. They had decided that
the purchase would have been worthwhile even if it were only

11For an explanation see A. Dixit and R. Pindyck, Investment Under Uncertainty, Princeton University Press:
Princeton (NJ), 1994.

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Section 2 Efficiency Implications of Proposed Access Pricing Regime

used one day a week. At first glance, it would seem that the
prospect of renting would only enhance the benefits that the
Joneses would derive from purchasing the weeder. However, the
Jones family are sophisticated thinkers. They reason that it might
be better to see if someone else on the street purchases the weeder
first. That household would bear the capital costs of the weeder
while the Joneses could simply rent it out for one day a week.
Under a proposal such as that of Smith for the mower, Jones
would only have to pay for the operating expenses of the weeder
– a negligible amount relative to the purchase costs. 12

Access regulation that neglects sunk investment costs creates a free-riding

problem among potential investors. Each chooses to delay investment and
wait for others to provide the infrastructure; with access regulation
freeing them from ever having to contribute to the investment. However,
with all investors realising this, no one investor is likely to take the lead.
The end result is delayed investment; with only the potential competitive
returns motivating investors. If, however, the investment costs are
insufficient to cover those competitive returns, investment will never take
place.13

So while it is true that for the current rail network in Victoria, the
assets already exist and access regulation will not change that; this is not
the case for new investment or for assets yet to be privatised. In those
situations, investors will look to past regulatory decisions – such as these
proposed pricing rules – to inform them about the regulatory environment
they will face after the fact. And these proposed pricing rules, by ignoring
prior investment altogether, sends the worst possible signal for future
investment. The costs in terms of delay and curtailed infrastructure
investment are potentially extreme with consequent implications for the
rate of economic growth in Victoria.

For the current case the neglect of sunk costs is even more
perplexing when one recognises that the existing assets are leased rather

12 Joshua S. Gans and Philip Williams “Efficient Investment Pricing Rules and Access Regulation,”
Australian Business Law Review, Vol.27, No.4, August, 1999, p.268. See also J S Gans and S P King, “When
Being First Doesn’t Pay”, The Australian Financial Review, Friday 30 January 1998, p 32.

13It is unclear at this stage how re-opened track might be treated. If the assets of those lines – as they already
exist – are treated the same as those elsewhere, what is Freight Australia’s incentive to re-open track;
especially where it could be subject to competition from access seekers.

June 2000 16
Section 2 Efficiency Implications of Proposed Access Pricing Regime

than owned by the access provider, Freight Australia. They were offered a
fifteen-year lease of the rail track from the Director of Public Transport
with two further renewal options that have already been exercised. Such
long-term leases are desirable as they provide Freight Australia with
incentives to operate and maintain the track almost as if they owned the
track themselves. The long-term lease is also desirable in that effectively
allows the lessor and lessee to share risk associated with the long-term
value of the rail track. Finally, the upfront payment to the government
presumably enabled it to write off debt earlier conferring further benefits
on the state.

However, consider the situation that would arise if it were known

that regulated access prices would exclude those lease payments because
the lessee had already paid them. No rational firm would take out more
than a very short-term lease; perhaps a year. They would be better off
waiting for another firm to take the lease and then free ride off that
decision by avoiding having to contribute to the lease payments. Indeed, it
is likely that, because the assets exist, no firm would rationally pay for
lease at all; operating on the belief that without potential private operators
the government would still operate the track and they could receive access
to it on terms that would apply to private track operators. The likely end
result is that a leasing or privatisation option would be closed for the
government; and any benefits resulting from that would be lost.

It is for precisely this reason that lease payments on existing assets

are not generally considered to be sunk by economists. This is because, if a
firm shutdown their activities, they could avoid these costs. For the
Freight Australia case, the fact that they have paid for a long-term lease up
front may covert lease payments into a sunk expenditure but, from a
regulatory perspective, it does not change the principle regarding how
lease payments should be considered. For both fairness and also to
encourage the optimal incentives for long-term commitments – such as
leases and investments – to be made, the fact that payments for half a
century were made upfront should not make one treat the payments as if
they were to be paid every year for that same period of time.14

14 Such perverse logic could go even further. Suppose that Freight Australia outsourced its maintenance
activities to another firm with a long-term contract. Would that then imply that those costs were no sunk
rather than on-going? From a regulatory perspective it simply should not matter.

June 2000 17
Section 2 Efficiency Implications of Proposed Access Pricing Regime

To be sure, from Freight Australia’s perspective, the proposed

regime does not rule out them earning a rate of return on the assets they
have leased. Interestingly, however, the rate of return is likely to be very
low if competition downstream is intense. In the extreme, another
provider could claim a sizeable market share without contributing at all to
the investment costs of the rail network. From this perspective, the
incentives to invest are likely to be lowest precisely where access
regulation is likely to be the most effective in promoting competition.

The neglect of sunk costs in the access-pricing regime creates an

environment of uncertainty in Victoria. The proposed pricing regime is
not even consistent on this point with regard to other related assets. For
example, the sunk capital in the Dynon terminals will be included in the
cost-base for pricing for access to those facilities. The reason given is that
the “capital costs are involved and because the service provided can be
more complex.”15 However, this explanation makes no sense whatsoever.
It is not clear to me why the so-called ‘sunk cost’ logic should apply to rail
networks but not the terminals.

Indeed, it is interesting to compare the treatment of existing assets

with new capital expenditures. There, even after these have occurred, the
costs associated with new capital can be recovered to some extent through
access pricing. However, after the fact, those expenditures will also be
sunk. The question is: if it is clear that not including new capital
expenditures as part of the cost-base for access pricing would be desirable
from the perspective of encouraging those expenditures, why would the
same logic not apply to existing assets or leases; the latter that was at least
up until last year a new expenditure from the perspective of Freight
Australia? The inconsistent treatment of expenditures related to existing
assets versus the Dynon terminals and new capital expenditure creates
uncertainty with respect to regulatory decision-making and imposes
further risks that will likely deter infrastructure investment in Victoria.

15 DOI, op.cit., p.19.

June 2000 18
Section 2 Efficiency Implications of Proposed Access Pricing Regime

The proposed access-pricing regime for the Victorian rail

network is likely to be highly inefficient from a dynamic
perspective. It provides incentives for distortionary
expenditures on new capital while sending a signal to
potential infrastructure operators in Victoria that they will
be unlikely to earn rates of return commensurate with the
social value of those investments. Given such regulatory
risks, new infrastructure investment and the purchase or
lease of privatised assets in Victoria are likely to be
delayed and potentially curtailed altogether.

2.4 Negotiations

The above analysis has implicitly treated the proposed access prices
as the access prices that will actually be paid for freight rail in Victoria.
However, one has to remember that this is a regime of ‘regulation by
negotiation’ and that the proposed access prices will only be implemented
in the event that the provider and a potential access seeker fail to reach
agreement in access negotiations.

The fact of negotiations softens an economist’s conclusions

regarding the likely productive and allocative inefficiencies that will result
from the access-pricing regime. These inefficiencies create costs for seeker
and provider alike and hence, during negotiations they will be ironed out
in the interests of maximising mutual profits. However, these
inefficiencies are not the only things that could be removed to increase the
joint profits of the access provider and access seekers. As King and
Maddock note “… firms will negotiate access prices and conditions that
suit them, not those which increase social well being …”16 They could also
come a pricing arrangement that will soften downstream competition
between them and hence, preserve monopolistic profits there. In the
extreme the only difference between this scheme and no access regulation

16Stephen King and Rodney Maddock, Unlocking the Infrastructure: The Reform of Public Utilities in
Australia, Allen & Unwin: Sydney, 1996, p.97.

June 2000 19
Section 2 Efficiency Implications of Proposed Access Pricing Regime

is the shift in distribution of monopoly rents from the access provider to

access seekers.17

However, it is this very shift in rent distribution that means that the
proposed access pricing arrangements are likely to impact negatively on
dynamic efficiency regardless of whether they are negotiated or imposed.
This is because the neglect of sunk assets diminishes the ability of the
access provider to earn a return of return on investments even when it
negotiates with seekers. Unless the provider and seekers can come to an
arrangement prior to investment taking place that shares such costs, the
low investment incentives provided by the neglect of investment costs in
the cost-based of the access price carries over. Any such prior agreement is
particularly unlikely in access negotiations such as this one.

In conclusion, taking into account the possibility of negotiations

means that the potential allocative and productive inefficiencies are likely
to be less extreme as those discussed above but also that the potential for
downstream competition to the benefit of ultimate consumers of freight
rail transport are similarly likely to be diminished. What remains,
however, are the low investment incentives and consequent dynamic
inefficiencies that are likely to be the largest costs imposed by the
proposed regulation.

17 For an elaboration of this argument see Stephen P. King and Rodney Maddock, “Light-handed Regulation
of Access in Australia: Negotiation with Arbitration,” Information Economics and Policy, 11 (1), 1999, pp.1-
22.

June 2000 20
Section 3 Other Rail Access Pricing Regimes

3 Other Rail Access Pricing Regimes

It is all very well to cite that a proposed access pricing formula will
create certain economic inefficiencies. One reason an inefficient pricing
rule is used is because of the difficulties or costs of implementing other
pricing rules that will relieve some of these adverse consequences.
However, the experience of rail access regulation elsewhere demonstrates
that other pricing rules are both implementable and are likely to generate
more desirable outcomes in terms of allocative, productive and dynamic
efficiency than that proposed for Victoria rail. In this section, the
alternative rail access prices imposed elsewhere are review while in the
next, the potential benefits of those alternatives are considered.

3.1 Australia

There are rail access regimes currently in place in NSW, Western

Australia, South Australia and for the NT/SA AustralAsia rail line. They
are summarised in Table 6.1 in the Appendix to this report. Each of these
adopts a floor/ceiling approach; although for the AustralAsia rail line a
competitive imputation rule is used where effective inter-modal
competition exists for a particular type of freight.

The floor/ceiling approach sets the bounds on access prices that

can be negotiated between rail access providers and seekers. The floor on
the price allows the provider to recover the incremental costs associated
with providing the rail service to the provider; although in the NSW case
these costs do not necessarily include common network costs allocated to
a line. In effect, this means that the access provider cannot be required to
subsidise an access seeker.

On the other hand, the ceiling is designed to reflect the stand-alone

costs of a particular line. In other words, the access seeker cannot be
charged a price greater than that that would justify them reconstructing
the line and by-passing the existing network. This is an appropriate ceiling
that avoids inefficient investment by potential seekers in rail

June 2000 21
Section 3 Other Rail Access Pricing Regimes

infrastructure. Notice that to achieve this the ceiling must include an

allocation for sunk investment expenditures; usually implemented on
asset valuations at replacement cost to take into account falling rail
investment costs that might arise form technological progress. Once again,
a replacement value approach is consistent with the rationale of avoiding
theoretical by-pass.

Effectively, the floor/ceiling approach constrains the access prices

to avoid cross-subsidisation of particular lines and also the extraction of
unreasonable monopoly rents from a particular seeker. Negotiated
outcomes will likely lie between these extremes. Hence, those outcomes
could take into account demand-side information and also provide for
incentives for productive efficiency and the like while allowing the
provider to earn a rate of return on existing assets.

In Victoria, the floor/ceiling approach was seen as “inappropriate.”

Many lines are only lightly used, so costs vary with time (e.g.,
weathering, weed control, clearing drains) rather than with use;
the variable cost caused by extra trains is minimal. The gap
between the floor (variable cost) and ceiling (stand alone cost)
would be large, so the approach would provide little guide to
pricing. Differences in ability to pay would be difficult to
determine given the nature of rail freight in Victoria (grain and
other commodities, but little coal or minerals). It was considered
that the interests of all parties (the Access provider and access
seekers) would be best served by having a simpler and more
transparent pricing approach.18

The first argument here, that costs are unrelated to use, is strange given
the decision to base pricing on a gross tonne km use that implies that costs
do vary with use. The second argument regarding the size of the gap is
also perplexing given that the goal of access regulation is to prevent abuse
of access terms with high pricing. The Victoria approach is simply
therefore to lower the ceiling. The gap is not the relevant consideration
rather the basis upon which the ceiling is determined. A large difference
between stand-alone costs and variable costs would normally be an

18 DOI, op.cit., p.19.

June 2000 22
Section 3 Other Rail Access Pricing Regimes

argument to consider investment costs in the basis of a price ceiling rather

than to neglect them as is done here.

Nonetheless, it is true that neglecting an entire class of costs does

make pricing simpler and potentially more transparent. However, in this
case, it is unclear how that serves the interest of the access provider
although to the extent that it fosters a low access price it is likely to be in
the interests of the access seeker.

3.2 International

Rail networks in other countries do have substantially different

geographic conditions than those in Australia. Moreover, the integration
and density of rail lines are higher; making congestion issues more salient.
Finally, in many jurisdictions, rail investment is still a government
responsibility and so the rate of return requirements are different to those
in Victoria.

Nonetheless, looking at table 6.2 in the Appendix to this report one

can see the common use of multi-part tariffs with fixed access charges to
assist in the recovery of fixed and investment costs and also usage charges
related to usage costs on a per km or gross tonne/km basis. This indicates
the potential non-linearity between weight and distance that is neglected
in the proposed Victorian pricing regime.

Once again this suggests that accounting for investment costs is

both feasible and implementable as part of access pricing without loss of
transparency and potentially, where negotiations are possible, without the
exclusion of access seekers specialising in low-demand forms of freight.

June 2000 23
Section 4 Towards a More Efficient Pricing Structure

4 Towards a More Efficient Pricing Structure

The experience in Australian and elsewhere demonstrates that the

type of pricing structure proposed for Victoria is almost unique; especially
in its disregard for investment costs. However, as demonstrated in Section
2, the pricing structure also poses problems for allocative efficiency, in
that usage charges exceed marginal cost, and productive efficiency,
because there are limited incentives for the network operator to engage in
cost reductions. Indeed, there are potentially incentives for costs to rise.

A preferred solution would be the following:

• A multi-part tariff with both fixed and usage charges.

• The usage charges could reflect an appropriate unit of the service,

likely to be contingent on the type of freight, as well as be a price
cap rather than a cost-plus price.

• The fixed charge could be designed so as to facilitate the efficient

recovery of investment costs utilising demand-side information to
reflect a downstream access seeker’s value on access as well as
incentives to prevent by-pass or cream skimming.

This type of pricing structure is both implementable (as demonstrated by

experience elsewhere) as well as preferable on all dimensions of economic
efficiency.

4.1 Taking into Account Investment Costs

A principal requirement of any pricing structure would be to take

into account investment costs. Some economists believe that this should
be done through a simple linear pricing, or usage charge, that reflected all

June 2000 24
Section 4 Towards a More Efficient Pricing Structure

of the costs associated with a line.19 However, to do this would cause

distortions to allocative efficiency in that a seeker’s decision to run an
additional train across the line will be dependent upon average costs
rather than marginal or incremental costs.

To overcome this problem, economists in general recommend a

multi-part tariff. The usage charges effectively reflect incremental costs
while the fixed component is designed to contribute towards investment
costs and generate appropriate investment incentives. Notice that it is
critically important that fixed charges do not relate to usage in this case; as
demonstrated by the lawnmower parable:
Notice that the reasoning of the Joneses would not change if
access seekers, such as Smith for the mower, were forced to
contribute towards capital according to use. To see this, suppose
that Smith also was forced to pay Jones for one seventh of the
capital costs (given that they use the mower for only one day per
week). A potential investor, such as Jones, would still be better off
waiting for another household to purchase the asset. In this case,
that provider would have to bear most of the capital costs
associated with the necessary idleness that accompanies mowers
and weeders. As providers of an asset are not compensated for
idleness that arises in such lumpy investors, under such access
regulation they are better off being a seeker rather than a
provider.

The idea of economic efficiency is not confined to the efficient use

of assets that have been created, it can also be applied to the
decision to invest in new assets. In particular, efficient investment
requires that investment takes place at a time that will maximise
the net benefits to society as a whole.

For Smith and Jones’ street, access regulation based on simple cost
recovery rules, while encouraging efficient utilisation of assets,
discourages efficient investment. Even purchases that might have
been individually optimal are delayed. Access regulation that
does not respect the incentives to invest encourages a problem of

19 John Freebairn, for example, recommends a marginal cost plus mark-up to ensure recovery of all the
network’s costs. His reasons are that this is simple than say a two-part tariff. However, this neglects demand-
side information as well as not providing incentives for cost reduction. It is basically a similar scheme to that
advocated for other Australian states. See John Freebairn, “Access Prices for Rail Infrastructure,” Economic
Record, 74 (226), September 1998, pp.279-285.

June 2000 25
Section 4 Towards a More Efficient Pricing Structure

free riding among potential providers. For these situations, the

access regime that focuses exclusively on efficient usage can
potentially discourage provision and hence, discourage any usage
at all. 20

Nonetheless, by fully allocating costs based on the relative value a seeker

places on the access service, it is possible to recover investment costs
efficiently while creating socially desirable investment incentives.21

Such pricing principles could also be applied to new capital

expenditure. Because the provider expects to share in the total costs of that
expenditure, the provider has an incentive to choose that investment
wisely. In this case, the fixed charges would not allow for a rate of return
on investment and could be based on actual expenditures; the so-called
historic cost approach to asset valuation.22 This would make the revision
of access pricing in the face of new investment both simple and
transparent to all concerned.

Finally, the relative value way of apportioning investment costs

also makes it easier to eliminate the costs of cream skimming. Access
seekers serving more valuable customer classes will not receive special
privileges and will be forced to contribute more to fixed costs. Thus, cost
recovery will mirror Ramsey-style logic thereby removing potential
distortions of each downstream competitor’s customer bases.

4.2 Incentives for Cost Reduction

While a multi-part tariff can ensure that allocative and dynamic

efficiency are enhanced, if the usage charges are purely cost-based, this

20 Gans and Williams, op.cit., p.268.

21For an economic analysis of the appropriate basis for valuing assets in the context of access regulation see
Joshua Gans and Philip Williams, “Access Regulation and the Timing of Infrastructure Investment,”
Economic Record, Vol. 79, No.229, June 1999, pp.127-138.

22 This approach has been suggested for electricity transmission network expansion. See Joshua Gans and
Stephen King, “Options for Electricity Transmission Regulation in Australia,” Australian Economic Review,
June 2000 (forthcoming).

June 2000 26
Section 4 Towards a More Efficient Pricing Structure

does not provide high incentives for the access provider to contain costs
and maintain track quality. This is because they are only forced to bear a
fraction of the costs concerned.

A high-powered incentive scheme would have the usage charges

take a form of a price-cap. In this environment, while the initial basis for
the charge is cost-based, the regulator sets forth a pre-determined price
reduction based on forecasts of efficiency improvements and the like and
commits to this price path of a period of time. Consequently, the network
will appropriate all of the cost reductions below that path over the period
and bear any cost blowouts. This gives it large incentives to contain costs.

Notice that these incentives are achieved by agreeing to cede to the

network operator some rents; especially arising from cost reduction. Some
people raise concerns that this means that the network will earn some
monopoly profits. However, when providing incentives it is often the case
that some rents must be left with the agent who is making the critical
decisions. In this regard, the rents are simply and incentive bonus (or
penalty) and not monopoly profits per se.23

4.3 Consistency and Transparency

The current pricing arrangement leaves many factors unaccounted

for – in particular, the allocation of network and new investment costs. In
addition, it is inconsistent in its application across different aspects of rail
in Victoria.

For this reason, it is important that any pricing scheme become

more detailed in considering these issues. Leaving key questions of rate of
return and cost allocation at the discretion of the regulator creates a poor
climate for investment and economic efficiency. Thus, there is an
immediate need for greater clarity in terms of the pricing guidelines
currently given.

23 Laffont and Tirole, op.cit., 1999.

June 2000 27
Section 5 Conclusions

5 Conclusions

The proposed access-pricing regime for Victorian freight rail falls

far short of standard criteria of economic efficiency. While it does promote
downstream competition, it does so imperfectly and in the process
virtually destroys the network operator’s incentives to reduce costs and
efficiently invest in quality improvements and new capital expenditures.
In this sense, it represents a form of regulation that neglects thirty years of
regulatory experience and economic analysis.

But more critically it sends very poor signals to potential

infrastructure investors in Victoria. The total neglect of asset value and the
inability of the provider to recover its past investment costs from seekers
gives providers very poor incentives to invest in infrastructure assets that
may be subject to access regulation. At best, it creates additional
uncertainty about an investment’s rate of return while, at worst, makes
investment in those assets of little private value.

Economic theorists have often mused about the notion that sunk
assets need not be recovered through regulatory pricing because the assets
would remain even if the regulated firm failed while it would be easier to
implement a low pricing outcome. Of course, this musing was well
understood to be based on a myopic viewpoint and regulators
everywhere have never taken such theoretical notions seriously. As a
practical matter, regulatory decisions send signals to the market place
about the future value of investment decisions and cannot be ignored.
That they have been ignored in the proposed pricing arrangements raises
much of concern about future regulatory decisions in Victoria.

In general, access regulation as a very useful means of promoting

downstream competition while preserving the efficiency benefits of
natural monopoly infrastructure. Indeed, the usual concern over such
regulation has long been that too great a proportion of investment costs
are included in usage charges and that the better means of recovering
these is through fixed charges. This way of regulating access to rail has
been successfully implemented elsewhere and it would seem appropriate
to impose a multi-part tariff form of access pricing for the Victorian case.

June 2000 28
Section 6 Tables: Approaches to Freight Rail Access Pricing

6 Tables: Approaches to Freight Rail Access

Pricing

6.1 Australian Approaches

Asset Valuation
State Pricing Methodology
Method
Floor/ceiling approach
based on direct Depreciated Optimised
NSW
costs/stand alone line Replacement Value
costs
Floor/ceiling approach
based on incremental Gross Replacement
Western Australia
costs/stand alone line Value
costs
Floor/ceiling approach
Depreciated Optimised
South Australia based on break even
Replacement Value
and ‘fair’ return levels
If effective competitive
substitute, competitive
imputation pricing rule.
Depreciated Optimised
If no effective
NT/SA AustralAsia Replacement Value
competitive substitute,
Railway with adjustment for
floor/ceiling approach
government subsidy
based on incremental
costs/stand alone line
costs
Queensland Not yet chosen n.a.
Tasmania Not yet chosen n.a.

June 2000 29
Section 6 Tables: Approaches to Freight Rail Access Pricing

6.2 International Approaches

Country Pricing Methodology Ownership and

Control

Austria Multi-part tariff with Government

fixed charge, and
variable components
based on gross
tonne/km and train-km

Denmark Multi-part tariff with Government

fixed charge, and
variable components
based on gross
tonne/km and train
speed

Finland Multi-part tariff with Government

variable components
based on gross
tonne/km and net
tonne

France Multi-part tariff with Government

fixed charge, and
variable components
based on train km and a
reservation charge

Germany Charges differentiated Government

by type of route, quality
of the route, 5 freight
categories with
adjustments for weight,
reliability and high
volume

June 2000 30
Section 6 Tables: Approaches to Freight Rail Access Pricing

Sweden Fixed charge per axle Government

per year which varies (Subsidised)
between types of rolling
stock; variable charge
based on marginal cost
with a charge per gross
tonne km differing
between types of rolling
stock and an operations
charge per train km; a
traffic control charge on
the basis of train-kms.
There is also provisions
for differential pricing
and also incentive
payments with bonuses
and fines

United Kingdom Multi-part tariff with Franchised

usage charge based on
incremental costs and a
fixed charge designed to
recover fixed network
costs with the use of a
price cap process.

United States Avoidable costs on per Government

(AmTrack) train-km basis with (Unsubsidised)
incentive payments and
penalties based on
performance.

June 2000 31
 Attachment A: Recent Research

Selected Recent Research Papers and Publications

by Joshua Gans24

Competition Policy and Regulation:

Joshua Gans and Stephen King, “Options for Electricity Transmission Regulation in
Australia,” Australian Economic Review, June 2000 (forthcoming).

Joshua Gans, “The Competitive Balance Argument for Mergers,” Australian Economic
Review, Vol.33, No.1, March 2000, pp.83-93.

Teresa Fels, Joshua Gans and Stephen King, “The Role of Undertakings in Regulatory
Decision-Making,” Australian Economic Review, Vol.33, No.1, March 2000, pp.3-16.

Joshua Gans and Richard Scheelings, “Economic Issues Associated with Access to
Electronic Payments Systems,” Australian Business Law Review, Vol.27, No.5,
December 1999, pp.373-390.

Joshua Gans and Philip Williams, “Efficient Investment Pricing Rules and Access
Regulation,” Australian Business Law Review, Vol.27, No.4, August, 1999, pp.267-
279.

Joshua Gans and Philip Williams, Access Regulation and the Timing of Infrastructure
Investment,” Economic Record, Vol. 79, No.229, June 1999, pp.127-138.

Joshua Gans, “Regulating Private Infrastructure Investment: Optimal Pricing for Access
to Essential Facilities,” Working Paper, No.98-13, 1998, Melbourne Business
School.

Telecommunications:

Joshua Gans, Stephen King and Graeme Woodbridge, “Numbers to the People:
Ownership, Regulation and Local Number Portability,” Working Paper, No. 2000-
08, Melbourne Business School.

24 M any of these papers can be accessed on the web through www.mbs.unimelb.edu.au/jgans/research.htm.

Attachment A Recent Research

Joshua Gans and Stephen King, “Using ‘Bill and Keep’ Interconnect Arrangements to
Soften Network Competition,” Economic Letters, 2000 (forthcoming).

Joshua Gans and Stephen King, “Mobile Network Competition, Customer Ignorance and
Fixed-to-Mobile Call Prices,” Information Economics and Policy, 2000,
(forthcoming).

Joshua Gans, “Network Competition and Consumer Churn,” Information Economics and
Policy, 2000, (forthcoming).

Joshua Gans and Stephen King, “Termination Charges for Mobile Phone Networks:
Competitive Analysis and Regulatory Options,” Working Paper, No.99-19,
Melbourne Business School, December, 1999.

Joshua Gans and Stephen King, “Regulation of Termination Charges for Non-Dominant
Networks,” Working Paper, No.99-20, Melbourne Business School, December,
1999.

June 2000 33
Attachment B Consultant Profile

"Incumbency and R&D Incentives: Licensing

Attachment B: the Gale of Creative Destruction," (with
Scott Stern) Journal of Economics and
Consultant Profile Management
(forthcoming).
Strategy, 2000

"Options for Electricity Transmission

JOSHUA GANS Regulation in Australia," (with Stephen
King) Australian Economic Review, 33,
Joshua Gans graduated in 1994 with a Ph.D. June 2000 (forthcoming).
in Economics from Stanford University. His
thesis concentrated on the determinants of “The Role of Undertakings in Regulatory
economic growth and the role of Decision-Making,” (with Teresa Fels and
technological progress. He returned to Stephen King), Australian Economic
Australia as a lecturer in the School of Review, 33, March 2000, pp.3-16.
Economics, University of New South Wales.
In 1996, he moved to Melbourne to take up a "The Competitive Balance Argument for
position as an Associate Professor at the Mergers," Australian Economic Review,
Melbourne Business School, University of Vol.33, No.1, March 2000, pp.83-93.
Melbourne. At present, Joshua is Economics
Editor of the Australian Journal of “First Author Conditions,” (with Maxim
Management and on the editorial board of Engers, Simon Grant and Stephen
Information Economics and Policy. King), Journal of Political Economy, 107,
1999, pp.859-883.
Joshua teaches MBA students introductory
microeconomics and also several "Efficient Investment Pricing Rules and
specialised subjects on innovation, game Access Regulation," (with Philip
theory and incentives and contracts. He has Williams) Australian Business Law
adapted a leading US textbook for the Review, 27, August 1999, pp.267-279.
Australasian context; Principles of
Economics (co-authored with Stephen King,
"Why Referees Don't Get Paid (Enough)"
Greg Mankiw and Robin Stonecash; (with Maxim Engers), American
published by Harcourt-Australia). Economic Review, 88, December 1998,
pp.1341-1349.
Joshua has also had extensive consulting
experience working on competition issues for
"Growth in Australian Cities" (with Rebecca
several law firms, private utilities and
Bradley), Economic Record, 74,
government agencies including the September 1998, pp.266-278.
Australian Competition and Consumer
Commission. His work spans a wide variety
of industries including telecommunications, "Industrialisation with a Menu of
electricity, gas, pharmaceuticals, banking Technologies: Appropriate Technologies
and financial services. and the Big Push", Structural Change
and Economic Dynamics, 9, 1998,
On the research-side, Joshua specialises in pp.63-78.
industrial organisation and applied game
theory. His particular interest is on the link "Contracts and Electricity Pool Prices" (with
between competition and innovation. He has Danny Price and Kim Woods),
also researched on the publication process Australian Journal of Management, 23,
in academia and his papers are part of a June 1998, pp.83-96.
forthcoming book Publishing Economics (to
be published by Edward Elgar in 2000). "Driving the Hard Bargain for Australian
Some examples of his publications include: R&D,” Prometheus, 16, March 1998,
pp.47-55.
"Network Competition and Consumer
Churn," Information Economics and
Policy, 2000, (forthcoming).

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Attachment B Consultant Profile