Should the government finance Russian Railways?
Advanced Public Finance
Elizaveta Dolmatova (ID 16209)
Russian Railways (RZD) is one of the largest transportation companies in the world and is one of
the largest enterprises in Russia. It is the sole owner of the rail track and key rail infrastructure in
Russia and one of the three largest transport groups in the world.
RZD is responsible for 43% of the countrys rail freight turnover (over 85%, excluding
pipelines) and approximately 30% of the countrys passenger traffic. It generates more than 1.6%
of GDP, 1.3% of all tax revenues and 3.5% of investments into the countrys fixed assets
(Annual report, 2013).
According to Annual report 2013 the group employs more than one million people; 1.5% of all
those employed in the country.
Russian Railways is a natural monopoly. The sole companys shareholder is the Russian
Federation. On behalf of the Russian Federation the authorities of the shareholder are
implemented by the Government of the Russian Federation.
Natural monopoly
A natural monopoly exists when economies of scale are so substantial that a single firm can
produce total business output at a lower unit cost, and thus more efficiently than two or more
firms (Sherer, 1980). Basically, the long-run average costs are falling over the wide range of
production rates (relative to demand) that only one firm can survive in such an industry (see
figure 1). Kin and Horn (1999) argued that Natural monopoly gives rise to a potential conflict
between cost efficiency and competition, with an increased number of competitors leading to
some loss of scale efficiencies.
Figure 1: Natural Monopoly
Source: economicsonline.co.uk
Russian Railway Company is a classic example of a natural monopoly, where competition may
lead to an inefficient market outcome. Once the huge fixed cost involved with rails network and
transport equipment, as well as trains are paid, each additional unit of rails service costs very
little. Having two railways companies split transportation service, each with its own railroads,
trains and transport equipment, would lead to a near doubling of price, because of low marginal
costs, high sunk costs and declining average costs.
Natural monopoly leads to the difficult dilemma of how to organize these industries so as to gain
the advantages of production by a single firm, while minimizing all the vices resulting from noncompetitive markets (Chang, 1997). For example, company could increase the prices of the
service for whatever amount they want. In this case, country, assuming the inevitability of
monopolization, either regulated private enterprises or nationalized natural monopolies in order
to deal with this dilemma. Alongside other conditions such as public goods, positive and
negative externalities, incomplete markets and imperfect or asymmetric information, natural
monopoly is an important market failure situation (under which a market economy fails to
allocate resources efficiently) that warrants regulation and nationalization (Kim and Horn, 1999).
Government Regulation
1. Tariff policy. The fundamentals of state policy with regards to natural monopolies, including
the principles of state regulation and forming of the tariff policy in the freight transport and
passengers transport sectors are determined by law. The primary aim of implementing a tariff
policy within the tariff corridor is to create economic benefit for Russian Railways, by
attracting additional financial resources for the development of individual public railway
transport facilities, solving technological issues, and enhancing the attractiveness of railway
transport as a means of cargo delivery.
The framework for tariff corridor is generally favorable for Russian Railways. Regulation is
generally based on cost-plus-profit mechanism and a rolling, three-year price cap annually
revised by the Federal Tariff Service.
2. Subsidies. The Government compensates RZD for loss-making service, resulting from the
low, regulated tariff prices.
Price regulation of transport carried out by the subjects of the Russian Federation takes into
consideration lower income passengers by offering affordable fares. As a result of this,
received revenues cover no more than 50% of expenses. Since 2011, the Government of the
Russian Federation has set a reduced rate on tariffs for using public rail infrastructure
services rendered by Russian Railways to provide passenger suburban and long distance
transportation. The resulting losses in Russian Railways revenue are offset by subsidies from
the federal budget. In 20112013, an annual amount of RUB 25 billion was allocated from
the budget of the Russian Federation for this purpose (Annual Report, 2013).
According to Annual Report 2013 the overall volume of state support of Russian Railways
from the federal budget, regional budgets and extra-budgetary funds was RUB 87.1 bn,
which is RUB 65.7 bn less than in 2012 (-43 %). In 2013, the government continued to pay
special attention to the implementation of state projects for the development of the railway
transportation infrastructure.
3. Investments. The State invests in projects that are commercially inefficient for Russian
Railways with payback period above 30 years. These projects may be financed only through
budgetary sources, since only the state budget can return the invested funds due to the
multiplier budget effect. There are two main branches of investments for government:
1) Investments aimed at removing infrastructural constraints;
2) Investments aimed at improving transport accessibility for population of the country.
To sum up, according to the research was made, the government should support Russian
Railways, because only through the government support mostly each citizen of the country could
take an advantage of average tariffs of tickets and availability of the railways.
Literature review:
Annual Report of Russian Railways 2013
Chang H.-J. 1997, Critical survey: The economics and politics of regulation, Cambridge Journal of
Economics 1997, Vol. 21, pp. 703-728.
Hillman A.L. 2009, Public Finance and Public Policy, New York: Cambridge University Press
Kim S.R. and Horn A. 1999, Discussion paper: Regulation policies concerning natural monopolies in
developing and transition economies, New York: United Nations.
Sherer F.M. 1980, Industrial Market Structure and Economic Performance, Chicago: Rand McNally
