Subadditivity Tests for Network Separation with an Application to U.S. Railroads

Abstract

We describe a pair of empirical tests that can be used to evaluate the technological feasibility of separating a vertically integrated network monopoly into a common infrastructure component and competing operating components. We implement the tests with a Generalized McFadden cost function that is globally concave in input prices and permits the assignment of zero output values without losing its flexibility properties. The tests shed light on the respective roles of regulation and competition policy. We illustrate them with an analysis of U.S. freight railroads for the period 1978-2001 and find both vertical and horizontal economies of scope.

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