Reforming a Network Industry: Consequences for Cost Efficiency and Welfare

To introduce competition in an industry with an upstream naturalmonopoly infrastructure requires vertical separation. However, given the well-knownadvantages of vertical integration, such a reform would have to reduce costs in order toincrease social welfare. We ask whether this would be the case if marginal costs dependon a downstream agency problem. It turns out that the opposite holds true. While entryafter vertical separation can be beneficial despite higher costs, the best solution in terms ofcost efficiency and welfare tends to be a welfare-maximising vertically integrated orbilateral monopoly. Vertical separation and competition are outperformed even by aprofit-maximising integrated monopoly.