Reforming a network industry: consequences for cost efficiency and welfare

Competition in an industry with an upstream natural monopoly infrastructure requires vertical separation. However, this cannot increase welfare unless marginal costs are reduced, given the advantages of vertical integration. It turns out that entry increases marginal costs and has ambiguous welfare effects if there is a downstream agency problem, and reduces marginal costs and increases welfare if it occurs upstream. While vertical separation and competition are outperformed even by a profit-maximising monopoly, a welfare-maximising vertically integrated monopoly yields, in both cases, superior cost efficiency and welfare.