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.

Since the publication by Williamson (1968) of his seminal paper on antitrust there has been a growing recognition by regulators of the need to assess tradeoffs between merger-related efficiency gains and merger-induced increases in market power. This paper addresses that need by presenting a structural econometric model of recent mergers in the U.S. rail industry. The paper extends the structural methodology by evaluating actual (as opposed to simulated) merger effects and by incorporating parametric estimates of merger efficiencies. The paper's empirical finding is that consumer surplus in U.S. rail freight markets increased by about 30 per cent between 1986 and 2001 despite dramatic industry consolidation.

THE PASSAGE OF the Staggers Act in 1980, which removed most federal economic regulations from the rail industry, provided the managers of U.S. railroads with a clear legislative sanction to earn a fair return on capital. To this end, they undertook a number of initiatives to rationalize their rate structure, input utilization, and scale of operations to increase returns to competitive levels. ' The number of Class I railroads has been reduced from 37 to 14; railroad labor has been trimmed 52 percent, and route mileage 29 percent. Rates of return have risen substantially, although by 1990 no railroad had consistently earned its cost of capital. Railroad companies have shared the benefits of deregulation with shippers, in the form of improved service and moderate real rates, and with shareholders, in the form of higher returns. Thus, managers have not 16. This has only been moderately successful, however, as Friedlaender and others (1991) point out.17. Friedlaender and others (1991). 18. During 1991 several of the major railroads, including Union Pacific and Norfolk Southern, took major charges to write down track, suggesting that this constraint may be easing.

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