III. THE THEORY OF RAILROAD RATES (Cont'd)
The law of increasing returns, 71.--Applied to declining traffic, 73.--Illustrated by the panic of 1907, 75.--Peculiarly intensified on railroads, 76.
Growth of mileage and traffic in the United States since 1889, 77.--Increase of earnings, 79.--Operating expenses, gross and net income, 80.--Comparison with earlier decades, 85.--Density of traffic, 86.--Increase of train loads, 88.--Limitations upon their economy, 92.--Heavier rails, 93.--Larger locomotives, 94.--Bigger cars, 95.--Net result of improvements upon efficiency and earning power, 97.
The law of increasing returns due to financial rather than operating factors, 99.
A railroad theoretically presents a clear example of an industry subject to the law of increasing returns--that is to say, an industry in which the cost of operation grows less rapidly than the volume of business done. Each ton of freight added to the existing traffic costs relatively less to haul. From this it follows, obviously, that the net returns increase more than proportionately with the expansion of traffic. This may be demonstrated by a simple calculation. It has already been shown that only about two-thirds of the total expenditures of a railroad are applied to operation, the remaining third being devoted to capital account. Moreover, of these two-thirds of the total applied to operating outlay, only about one-half responds to any change in the tonnage, the other half being constant up to a certain point. Otherwise expressed, an increase of one per cent, in traffic and, therefore, of revenue, produces an increase in expense of only one-half of two-thirds of one per cent.[50] Two-thirds of the entire increment of revenue goes to profit. Carry this increase further and the effect is more striking. Suppose traffic to grow tenfold. The former outlay being $100 for a given volume of business, would be divided according to our rule as follows: one-third for fixed charges, one-third for constant operating outlay and one-third for variable expenses. With ten times as much traffic, only the last group of outgoes will expand. One thousand dollars revenue would therefore become available under the new conditions, to pay the same fixed charges as well as constant operating costs. The total outgo would thus become $33 plus $33 plus $330, or $396 in all. Almost two-thirds of the increment of revenue still remains as profit. It might well happen that such an expansion could not ensue without large increases in the capital and plant, as has already been noted; but up to that point this calculation would hold good. The following statement varying but slightly from our foregoing assumptions, illustrates the principle.[51] Let the distribution of expenditures for given conditions, producing $100 of revenue, be these, viz.:
Operating expenses $ 67 Fixed charges $ 28 ---- $ 95 Profits for dividends $ 5 ---- $100
Now assume an increase of ten per cent. in the traffic and consequently in the revenue; but assume also that the average extra cost per unit, of the new business, is only forty per cent. as much as for the preëxisting tonnage. Were the added cost of each ton mile as great as before, the operating expenses would rise by the full ten per cent. of $67. But on Webb's assumption, they will rise by only forty per cent. of ten per cent. The new account would then stand thus:
Operating expenses ($67 plus forty per cent. of ten per cent. of $67) $ 69.68 Fixed charges as before $ 28.00 ------- $ 97.68 Income, increased by ten per cent. $110.00 ------- Balance for profit or dividends $ 12.32
By an increase of ten per cent. in tonnage, balance for dividends has more than doubled.
In this connection it will be noted that a constant rate of return per unit of business newly acquired has been assumed. Attempts were made on behalf of the railroads, during the long period of decline of ton mile revenue down to 1900, by Newcomb and others, to show that this is an unreasonable assumption; in that increased traffic is presumably to be had only by a progressive lowering of the rates charged. This contention has been effectively demolished by the steady and remarkable growth of traffic since 1900, even in the face of a substantial rise of rates all along the line. A necessary corollary to our proposition, beside that of the maintenance of a constant scale of charges, is, of course, also of the continuance of a given grade of service and of costs of operation. If more luxuriously appointed passenger trains or quicker freight service have to be given in order to produce the growth of business, the added costs of operation must, naturally, be taken into consideration. If widespread rise of wages follows an increase in the general cost of living, that too is an entirely extraneous factor. But with a given grade of service, constant rates and steady wage scales, there can be no question, up to the point of full utilization of the existing plant, that the operation of railroads affords clear demonstration of the law of increasing returns.
The obverse side of the law of increasing returns is also of great importance. For the same reason that when traffic increases, only a portion of the expenses are affected, it follows that, when business declines, only a part of the costs can be lopped off. In other words, a reduction in the volume of traffic does not in itself alone lead to a corresponding reduction in the operating expenses. Of course, many of these latter may, as we have seen, be temporarily postponed, as they were in 1893-1897, especially in the group of maintenance-of-way expenses. In such an event they must ultimately be made good by extraordinary outlay at some later time. But, unless they be thus postponed and unless the rates charged for service be reduced in order to stimulate traffic, it is inevitable that the margin of profit will drop as rapidly as it tends to rise with increased volume of business. This may be illustrated by the following computation.[52] Assume the total revenue from a given business to be $100, and assume it to be distributed as before, viz.:
Operating expenses $ 67 Fixed charges $ 28 ---- $ 95 Leaving profit $ 5 ---- Total $100
A positive decline of ten per cent, in the tonnage, if the cost for operation per unit of the portion lost was the same as the rest, would obviously reduce the operating expenses also by ten per cent. Let it next be assumed, as was done previously, that the average extra cost per unit of the latest increment of business was only forty per cent. as much as for the remainder of the tonnage. How closely this will approximate the facts in any particular instance will depend upon the density of traffic attained in relation to the capacity of the existing plant. If the addition of the last ten per cent. of business did not increase the large proportion of fixed expenses at all, and only added forty per cent. per unit more to the variable expenses; per contra, the loss of it would merely reduce the variable expenses and still leave the constant outlay the same. On this assumption, by the loss of ten per cent. of business the total amount of operating expenses under the new conditions would be lessened, not by ten per cent. of $67, but by only forty per cent. of ten per cent. of $67. The income would, however, decline by the full amount of ten per cent. The account, after a loss of ten per cent. of business, would then stand somewhat as follows:
Operating expenses ($67 less forty per cent. of ten per cent. of $67) $64.32 Fixed charges, as before $28.00 ------ $92.32 Income, reduced by ten per cent. $90.00 ------ Leaving a deficit of $2.32
Or, in other words, a decline of ten per cent. in tonnage has transmuted a five per cent. dividend condition into one involving an actual deficit nearly half as great as the former profit. The sudden reversal from apparent prosperity to very real distress, such as occurred during the fall of 1907, is thus explained. Its suddenness may be shown by the following table of monthly gross and net earnings, promulgated by the Interstate Commerce Commission.[53] The acute panic occurred during October, but its effect was not apparent until the following month. The total mileage included is shown by the first column:
=============================================== | | | Earnings | | | --per mile-- | | |------------------- | | Mileage | Gross | Net -----+-----------+---------+---------+--------- 1907 | July | 223,900 | $1,022 | $304 1907 | August | 224,100 | $1,079 | $345 1907 | September | 224,300 | $1,045 | $314 1907 | October | 224,700 | $1,116 | $337 1907 | November | 224,800 | $981 | $261 1907 | December | 224,400 | $861 | $197 1908 | January | 198,700 | $746 | $148 ===============================================
This table shows that whereas under full prosperity, up to and including the month of October, the net revenue was about thirty per cent. of gross; after the sharp decline in traffic, it dropped in November to twenty-six per cent., and progressively thereafter to twenty per cent. in January. In other words, a decline of about one-fourth in the gross revenue within four months, entailed a loss of over fifty per cent. in net earnings. Higher operating expenses in the winter may have exaggerated this tendency, but, on the other hand, drastic economies were put into effect, which would more than offset the difference.
The urgent need of at once meeting any loss of business by prompt reduction of operating expenses is apparent. But there is comfort to be found at this point in the fact that each one per cent. saved in operation at any given time, results in saving two per cent. for the net earnings. According to our estimates, and as a rule practically, operating expenses equal about two-thirds of gross revenue, leaving one-third to meet charges and pay dividends. Every reduction from this two-thirds of gross revenue, therefore, transferred to the balance, increases the latter proportionately twice as much. This fact in turn explains the urgent pressure always brought to bear at such times to effect economies all along the line. These are too often indiscriminately made.[54] Such paring down of expenses should always be made with an eye to their ultimate effect upon the operating efficiency of the property in the long run. To postpone much-needed repairs of equipment during a period of depression, like that of 1907-1908, when repair shop costs are at a low ebb, only to hamper operations and to effect repairs under pressure when business revives, is an instance of such wasteful economy.
The qualification of the law of increasing returns as applied to railroads, arising from the distinction between long and short term production of its commodity--transportation--as above described, is of course by no means confined to carriers alone. It holds good of a factory or mercantile establishment as well. But in the case of railways, it is emphasized by the abruptness with which the condition of congestion of plant arises. The limit of full working capacity in a factory is elastic, by reason of the fact that under the "peak of load"--in busy seasons--it may prolong operations beyond the daylight hours or, at worst, work all night by double shifts. But a railroad, customarily working by night as well as by day and thus distributing its operations over the entire twenty-four hours, enjoys no such expansible limits upon utilization of its plant. When such full utilization is attained, the end comes suddenly. No postponement to a more favorable time for raising funds for better terminals or four tracking the main line is possible; nor does its character as a public servant permit a railroad to curtail service. The dead wall of congestion cannot be gotten around by either path. A crisis is presented, calling for the most heroic measures. This, of course, still further emphasizes the need for a long look ahead into the future with respect to railroad finance; not for the management alone, but for the government as well, charged as it is at present with control over rates for service.
* * * * *
The application of the law of increasing returns to railroads in actual practice is beset with difficulties. In order to make these clear, it will be necessary first to describe the phenomenal development of this country which has taken place during the last two decades.
The freight service of the railroads of the United States, measured by weight, in 1910, amounted to 1,026,000,000 tons. Only since 1899 when the corresponding figure given by the Interstate Commerce Commission was 501,000,000 tons, have accurate data been obtainable. This would indicate a growth in ten years of about one hundred per cent. But this figure takes no account of the distance each ton of freight travels. This factor is included in what is known as ton mileage--that is to say, the equivalent of the number of tons of freight carried one mile. Obviously, so far as the amount of service rendered is concerned, one ton carried a hundred miles is the equivalent of one hundred tons transported one mile. Every carrier totalizes in this way each ton of freight movement by multiplying it into the distance transported. For the United States as a whole, this ton mileage in 1910 was 255,016,000,000--that is to say, the service rendered would be represented by the carriage of that number of tons one mile. The appended diagram shows the phenomenal rapidity with which this transportation service has grown since 1899. The scale on the left hand side of the chart serves this purpose. The right hand scale indicates the miles of line in operation.
The rapid growth up to 1893 was suddenly interrupted by panic and subsequent industrial depression lasting for about four years. Recovery began in 1897, since which time the freight movement has increased by leaps and bounds from about 95,000,000,000 ton miles to 255,016,000,000 ton miles in 1910. It is obvious that the growth of transportation in any country is bound to be more rapid than the increase either in population or in wealth. It appears, indeed, almost as if the volume of transportation in the United States increased more nearly as the square of population than in direct proportion. It has been estimated that we forward two and a half times as much freight per capita as some of the leading European countries like France. Our domestic population from 1890 to 1910 increased about fifty per cent. The railroad mileage grew at about the same rate. Yet the freight service surpassed this rate of growth more than six times over; and the passenger service augmented nearly as much. Both alike in 1910 were practically three times as great in volume as twenty years before. The diagram on page 78 is intended to illustrate the relative rapidity of this development. While population and mileage increased about one half, the railroads in 1910 hauled the equivalent of three times the volume of freight traffic handled in 1890. At the beginning of this period, the railroads had to seek the freight. Now it appears that traffic normally will seek the railroads. At times, even, as in 1906-1907, the railroads have actually sought to escape the flood of business presented.
The magnitude and importance of the growth of tonnage, as above described, is revealed by the rapid increase in railroad earnings. The course of these is shown by the succeeding chart on page 82. Gross revenues of American railroads in 1889 were about one billion dollars. In 1910 they amounted to $2,750,000,000. Thus it appears that gross earnings almost equalled three times the amount of twenty years ago. The net income available for dividends has grown even faster. The increase was, roughly speaking, about five fold; namely, from 101 millions in 1889 to 515 millions in 1910. Nearly three and one-half times as much money went annually to the owners of railroad securities as dividends and interest, besides leaving surplus earnings for 1910 of about 222 millions available for improvements and surplus. But the limit of utilization seems to have been about reached on many roads in 1906; and an era of extensive new capital outlay to increase the existing plants and facilities ensued. Indications are not lacking to show that at the height of activity before the industrial collapse of 1907-1908, such a point of saturation had been reached, especially in trunk line territory and on the northern transcontinental lines.[55] On the Northern Pacific, for instance, the ton mileage increased from 2.2 billions to 5.2 billions between 1900 and 1906. The Northwest was suddenly confronted at that time with the new issue of enlarging facilities, which had been slowly becoming apparent elsewhere in the country during the preceding decade. Grain actually rotted on the ground, and an acute coal famine occurred, because of sheer inability of the roads to care for the new traffic. Changes in methods of business also somewhat exaggerated this strain upon the carriers. Merchants now expect quick delivery to order. They object to stocking up months ahead, even when conditions are auspicious; therefore, business, when especially stimulated, comes with an irresistible rush. All these causes, coupled with undiscriminating attempts by inadequately bedded roads to imitate the methods of progressive ones by prematurely increasing their train loads, led to a practical breakdown of the transportation business of the country in the autumn of 1906. To the student of transportation, this congestion denoted the attainment of a point of saturation for the then-existing physical plant. The analogy to the case of the Pennsylvania Railroad, previously described, is obvious. Such a predicament is bound to arise in the development of any carrier in a rapidly growing country. Its fiscal significance will appear in due time.
A comparison of the growth of business and of operating expenses for the entire railroad system of the United States over a series of years is given in the following table. The results are expressed by means of index numbers based upon the year 1880, taken as 100.[56]
RELATIVE INCREASE IN TRAFFIC ITEMS, OPERATING EXPENSES AND REVENUE FROM 1880 TO 1906, INCLUSIVE
====================================================================== | --Average, from and inclusive-- Items | | 1881 | 1886 | 1891 | 1896 | 1904 | 1880| to | to | to | to | to | | 1885 | 1890 | 1895 | 1898 | 1906 ---------------------+-----+--------+--------+--------+--------+------ Ton miles of freight | 100 | 134.36 | 203.23 | 264.90 | 313.81 | 595.0 Passenger miles of | | | | | | passengers. | 100 | 138.12 | 189.46 | 233.15 | 224.65 | 412.0 Operating expenses | 100 | 132.75 | 174.39 | 215.30 | 221.42 | 394.0 Gross income from | | | | | | operation | 100 | -- | -- | 183.0 | 190.0 | 346.0 ======================================================================
From this table it appears that between 1880 and 1906 the ton mileage of freight increased about six fold, and the passenger business more than four fold. Operating expenses, on the other hand, were in 1906 less than four times as great as in 1880. Increasing returns are quite evident. The period from 1880 down to 1896-1898, before the recent general increases in prices and wages took place, shows this even more strikingly. In order to transport more than three times as much freight and two and one-quarter times as many passengers, it required a direct outlay for operation of little more than twice as much money.[57] On the other hand, owing to the rapid rise of all operating costs since 1898, a comparison of expenditures confined to the last ten years by themselves, affords an apparent contradiction. The results for this period have already been given, classified in greater detail. And yet, despite this disturbing factor and the one earlier mentioned that these later operating expenses have been heavily loaded with improvement expenditures, it appears by comparison of 1895 with 1905, that passenger business has more than doubled, and freight business is two and a half times as great, while operating expenses in 1905 were not much over twice their amount ten years before.
A comparison of the movement of gross earnings with operating expenses introduces still another disturbing factor, namely, the changes from year to year in the level of freight rates as well as in the character of the traffic handled. The effect of fluctuating costs of production of transportation having just been considered, we may now turn to the fiscal returns as affected by the price obtainable for the service given. Any long-time comparison of results reflects the influence of the steady decline of freight rates during the generation prior to 1900. Thus comparing 1880 with 1898, as shown by the preceding table, operating expenses grew in the ratio of 100 to 221, while gross income grew from 100 to only 190. Three fold the freight business produced less than twice the revenue. Pushing the comparison later, down to 1906, operating expenses grew after 1880 from 100 to 394, while gross income rose to only 346. This reflects the influence during the last few years of the rapid rise in prices and wages.
* * * * *
According to the opposite diagram, comparing 1890 with 1910, both operating expenses and gross income from operation seem to have moved together; the curve of gross revenue rising proportionately only a little faster than that for operating expenses. The latter have risen from a general figure of about $800,000,000 before the depression of 1893-1897, to $1,822,000,000 in 1910; the former from about $1,200,000,000 to over $2,750,000,000. Both alike somewhat more than doubled, therefore, in twenty years. At times, especially during the rapid revival of business after 1897, before rising prices began to affect costs of operation, extraordinary increases in earnings appeared, outstripping the growth of expenditures. Comparing the year 1899 with 1895 we find that the gross earnings of the railroads of the United States increased by twenty-two per cent. This involved an increased expense of operation, however, of only eighteen per cent. Similar comparison year by year, there having been an enormous expansion of business, shows an increase in gross earnings somewhat more rapid than the growth of operating expenses. This differential advantage has progressively lessened since 1902, and especially since the let-up in 1907. The official returns for 1911 with the marked decline in gross, show an even more distinct drop in net earnings. Whether the need of an increase of rates commensurate with the augmented operating costs is imperative, can only be ascertained after a return to more normal business conditions.
These relationships would be the more striking could we exclude the enormous expenditures for betterments which have been charged to operating expenses during these years. Comparisons of net earnings are vitiated by uncertainty upon this point. Working over these results by comparison per mile of line, it appears that the rate of increase in earnings per mile of line for five years prior to 1900, was approximately double the rate of increase of operating expenses per mile of line. The greatly lessened cost of performing additional business becomes at once apparent. But these latter conclusions, as has been said, cover only a brief period of time. Judging by the results over many years, it appears that changes both in the level of freight rates and of wages and prices have operated to leave the railroads not much better off than they were some time ago. The only thing which has saved them whole in the face of rising prices and wages since 1900, and especially since 1907, has been the rise of freight rates and the enforced improvements in operation. With the methods of transportation, such as size of cars and locomotives and train loads, as they were a decade ago, very real distress would be more widely apparent than it is. On the whole, the public seems to have shared in the benefits of these improvements to a considerable degree. This statement, however true for the entire railroad system of the country as a whole, does not by any means represent the facts for any single system. Moreover, it is not by any means clear how fully the railroad system of the country has been enlarged and improved out of surplus earnings. There is reason to think that foundations in some cases--the Pennsylvania road, for example--have been laid during these prosperous years, for largely increased tonnage in the immediate future without a corresponding growth of expenses chargeable to plant; in other words, that the transition to a distinctly higher grade of operation has been effected out of surplus earnings.
The comparison of gross and net earnings from operation, if expenditures have grown almost as fast as gross income, confirms the preceding conclusions. Surveying the chart for the period since 1890, it appears that net earnings for the railroads of the United States have more nearly trebled than doubled; the increase having been 177 per cent. up to 1910. This takes no account whatever of the immense volume of new capital added to the system. The entirely distinct question of the relative rate of return upon the investment will engage our attention at a later time. Examination of the years of rapid revival after 1897 by themselves, however, especially for individual companies, shows striking results. This is especially true of roads, not then developed up to a fair working capacity for their plants.
An interesting comparison with the previous decade, 1870 to 1880, exemplifies this relation still further. The gross earnings of the trunk lines of the United States decreased very greatly per mile of line from $7,211 in fact to $6,636 during the decade; but at the same time the net earnings steadily increased. This was due primarily to the great volume of business developed,--the ton mileage increasing more than three fold during these ten years. It happened despite the fact that the miles of line during the same period had more than doubled. The following decade, 1880 to 1890, was represented by an increase of only 82.7 per cent. in mileage, while the number of tons of freight hauled one mile increased by 132 per cent. Density increasing in this way, a corresponding ability to carry at a lower rate per ton was a necessary result. So indisputably has this law--that an expanding volume of business up to a certain point, may profitably be carried at a continually lowered cost--been proved, that it is estimated by so competent an authority as the Engineering Review that, provided sufficient tonnage be available for 2,000-ton freight train loads, a cost of one mill per ton mile can be attained. Its significance may be realized from the fact that the lowest revenue per ton mile reported for the United States is 2.21 mills per ton mile for the long haul soft coal business of the Chesapeake & Ohio.[58] This, of course, does not imply that any railroad in actual operation, carrying all kinds of freight including a large proportion of local traffic, can in the immediate future hope to attain this result. It is intended only to show that, provided the volume of traffic be large enough, the cost of operation tends to decline as a matter of course, until a condition of congestion for the existing plant has been reached. At this point a new cycle of costs of operation and of profits makes its appearance.
The most important single factor in the production of increasing returns upon a railroad is the density of traffic; that is to say, the amount of business which can be conducted with a given set of rails, terminals and rolling stock. In other words, it is the degree of effective utilization of the plant and equipment. It is too obvious to need demonstration, after what has been set forth concerning the nature of railroad expenditures, that economy of operation and, consequently, profits are more or less directly dependent upon this fact. Such effective utilization of the property may be secured in two ways: either by a large tonnage per mile of its line, or else by a concentration of such traffic as it may have into large train loads, which can individually be transported at low cost. The first of these economizes the fixed expenses for roadway and line which respond but slowly to enlargement of traffic, by distributing them thinly over a large tonnage; the second economizes the mere movement expenses which tend to grow less rapidly than the size of the trains. For neither fuel consumption nor wages of train crews expands pari passu with the paying load. Fortunate the lot of the railroad which enjoys both these advantages, of density of traffic per mile of line and of tonnage capable of such concentration in heavy train units.
Traffic density--the tons of freight carried one mile per mile of line--is readily computed. The ton mileage, representing the total transportation service, is merely divided by the number of miles of line operated. The following graded table illustrates the wide range of this figure, according to the location of different companies and the nature of their business, as well as the change in the last few years.[59]
======================================================================== | 1902-3 | 1910 |--------------------------------------+--------- | |--Percentage of tonnage-- | | |--------------------------| | Traffic | Agric'l|Products| Manu- | Traffic | density |products|of mines|factures| density ---------------------+-----------+--------+--------+--------+--------- Rock Island Company. | 428,116 | 25 | 29 | 14 | 581,000 C. M. & St. P. | 605,139 | 23 | 24 | 17 | 709,000 Great Northern | 657,102 | -- | -- | -- | 814,700 N. Y., N. H. & H. | 802,954 | -- | -- | -- |1,057,000 Wabash | 885,208 | 24 | 32 | 9 |1,322,000 Baltimore & Ohio | 2,181,518 | 6 | 62 | 8 |2,711,000 New York Central | 2,163,000 | 16 | 44 | 12 |2,548,000 Lake Shore ('05) | 3,355,209 | -- | -- | -- |3,911,000 Penn'a Railroad ('05)| 6,337,625 | -- | -- | -- |5,139,000 ======================================================================
The first of these companies operates in a sparsely settled agricultural territory. The St. Paul system lies nearer Chicago, but is still largely dependent upon a local and rural constituency. The Great Northern--a great transcontinental trunk line--despite its sparsely settled western area, exchanges a large volume of through freight for the Pacific Coast for lumber and other bulky products carried east. The New Haven serves perhaps the most densely settled area in the United States, but much of its traffic is on branch lines and is of a retail character. The Wabash lies in well settled territory and hauls a heavy tonnage of low-grade freight. The last two are not only great trunk lines to the seaboard, but also tap the coal and iron fields. Much of their tonnage is consequently of low grade. The Pennsylvania enjoys a still further advantage, super-adding a rich local traffic in manufactures and merchandise. As compared with its rival trunk line, the New York Central, it hauls relatively little grain; but, on the other hand, the New York Central has a much smaller coal and iron business. Some one has aptly characterized the difference between the two roads, describing the New York Central as "operating between good points, but not through a good country" so far as local business is concerned. On the one, through traffic is supplementary to local business, while on the other it is the reverse. The high density of trunk line traffic is such that about two-thirds of all the tonnage of the United States is transported east of the Mississippi and north of the Ohio river.
Traffic density has enormously increased during the last two decades, as a result of the filling up of the country and the relative cessation of new construction. This is manifested by the growth since 1890. In that year the density was less than 500,000 ton miles per mile of line, and during the depression of 1893 it fell well below that figure. The total of 1,053,000 reported for 1911 represents, therefore, more than a doubling of the density in twenty years. This growth during 1898 and 1905-'06 was notable. The latter period, especially, was a time when congestion upon all the roads of the country occasioned much distress. The fact is evident that the country has well grown up to the measure of its existing transportation facilities.
The second measure of effective operation for the production of increasing returns, is concentration in the trainload. This is regarded by many as the supreme test of efficiency in management. Great progress has been made during the past years in this regard in the United States--an improvement which has largely enabled the carriers to bear up under an increasing burden of expenditure. The trainload is generally adopted today as the unit of operation, measuring the cost of service.[60] It is a fact that, within certain limits, the cost of handling a train does not vary greatly with its capacity. Since the first application of air-brakes to freight trains in 1887, a train crew sufficient to handle fifteen cars can care for thirty about as well in long haul wholesale business. Fuel cost, also, as has been shown, lags well behind the rate of increase of the load. Eaton in his Railroad Operations, concludes that from thirty to fifty per cent. of cost is independent of the trainload. The effect is that any increment in the paying load very materially decreases the cost of operation per ton.
Progress in the United States in increasing the average train load is shown by the lowest curve on the diagram on page 97. The scale applicable is along the left hand side of the chart. From 175 tons per train in 1890 to an average figure of 383.10 in 1911 is certainly a remarkable showing. The most rapid increase seems to have occurred after 1897, with the first resumption of general prosperity. As for individual roads, the following table of average train loads is suggestive, as showing the gradation between roads of different type, as well as progress from year to year:
AVERAGE NUMBER OF TONS OF FREIGHT PER TRAIN (TONS PER TRAIN MILE)
============================================================== Road (Fiscal Years) | 1901 | 1905 | 1910 -----------------------------------------+------+------+------ Pennsylvania Railroad (East of Pittsburg)| 478 | 498 | 649 Pennsylvania Company (West of Pittsburg) | 382 | 420 | 511 Pennsylvania System (Both) | 454 | 476 | 607 Chesapeake & Ohio | 511 | 557 | 701 Great Northern | 347 | 541 | 520 Erie Railroad | 379 | 416 | 497 New York Central & Hudson River | 365 | 381 | 413 Northern Pacific | 324 | 367 | 429 Atchison, Topeka & Santa Fe | 238 | 265 | 298 Chicago & Northwestern | 255 | 259 | 261 New Haven | 208 | 222 | 293 Southern | 190 | 194 | 237 ==============================================================
The great coal and iron roads, the trunk lines and the transcontinental lines all concentrate their business; while the granger roads, like the Atchison and North Western, the roads with much local business like the New Haven or the Southern, operating in sparsely settled regions, all have of necessity smaller trainloads. But all alike betray remarkable progress in this regard. In 1870 the average for the best roads was little above 100 tons,--such as 103 tons reported for the New York Central and 137 tons on the Lake Shore. From this level to results of 400 or 500 tons on the average represents a notable achievement. The Lake Shore for 1911 reports a revenue train load of 635 tons. It should be observed, however, that such results come from longer trains, not, apparently, so much from larger cars. To raise the average trainload on the Wabash from 196 tons in 1890 to 386 tons in 1908 is also worthy of note. The significance of these recent figures can be realized from the fact that the London & North Western, one of the leading railroads in Great Britain, reports recently an average freight train load of only 68 tons. This represents probably a fair average for European railroads as a whole, although in England the general practice of privately owned cars, of light locomotives, short freight sidings, etc., may reduce the figure slightly below the continental average. Statistics not only show the notable improvement in recent years; they at the same time show how the trainload performance is affected by trade conditions. For nearly every road the trainloads for 1904 were distinctly lower than in the preceding years. This was a year of acute business depression. The movement of great staple commodities, such as iron ore, coal, steel and iron and lumber, was greatly curtailed. All business was conducted on a narrower basis. Smaller trainloads were an almost inevitable consequence. The revival in the following year, however, immediately improved the conditions of operation, as the figures indicate.
It will be noted that the figures for the American roads above given represent averages. These are compounded from local and through traffic taken together. It is apparent at once that local trains must average far lighter loads than are customary upon long hauls without breaking bulk. Thus New England railroads report for 1906 an average trainload of only 220 tons, while other parts of the country, such as the North Central group, report 426 tons of paying load. Only by separation of local from through business can we adequately appreciate the enormous advances which have taken place in railroad operation in the United States, with corresponding reductions in the cost of transportation. While the New York Central at one time reported an average trainload of 322 tons, the average load of its through trains on the main line rose as high as 750 tons. More than twice this figure is attained upon the Pittsburg, Bessemer & Lake Erie road in hauling ore from the lakes to the furnaces at Pittsburg. The Illinois Central, for its low grade and long haul to the Gulf, has recently built locomotives capable of hauling 2,000 tons of net paying load. A standard grain train on the Lake Shore in 1903 consisted of fifty cars holding forty tons each. Even this figure has recently been surpassed by the New York Central, which, with its monster new "mogul" engines, hauls eighty loaded 30-ton cars, giving 2,400 tons of revenue freight. The Mallet locomotives with a tractive effort of 100,000 lbs., at present seem to have reached the limit of size and weight. Seventy-five grain cars holding 1,000 bushels apiece are equivalent to the production of twenty bushels per acre of an area of six square miles. This is an ordinary trainload. It is not infrequent to transport a fifth more than this. Eighty and even one hundred cars in a train since 1900 often bring the load up to 3,600 and even 4,000 tons of freight. Such a train is over four-fifths of a mile long. From these figures it certainly appears that trainloads for long haul are standardized at not less than 2,000 tons, a figure which would have seemed absolutely impossible to railroad managers of fifteen or twenty years ago. The maximum trainload in Germany on coal traffic, which, of course, greatly exceeds any general average for trains of all classes, is about five hundred tons. It has been regarded as a notable achievement that this represents an increase of about one hundred tons in the last decade.
On the other hand, the extravagant promises of economy from large trainloads have been considerably abated of late. It has been effectively demonstrated that there is a limit to such growth. Only low-grade and long haul carload traffic can profitably be concentrated. In 1903, for instance, a general decrease in trainloads followed a reduction in the relative amounts of low as compared with high grade tonnage. Less iron, coal, and raw materials and more merchandise and manufactures offered for carriage, necessitated a positive reduction in the trainloads as already mentioned. Nor can local business in less than carload lots profitably be concentrated beyond a certain point. Grades must be uniform to attain such economy. The trainload must not exceed the traction power on the heaviest inclines, or else expensive pusher engines or breaking up of trains will offset all other savings. Moreover, too great trainloads even on the best roadbeds involve slower speeds. Not only is other traffic thus impeded, but the economy in wages vanishes after a certain point with such slower movement. The fashion had been set by James J. Hill, the master mind in the transcontinental field. His notable results, due to a careful working out of every detail, led to a frenzied imitation on all sides. Many roads then discovered to their loss that while they had provided rolling stock for heavy loading, ampler terminals, longer sidings and heavier bridges also were a necessary accompaniment. Part of the congestion of traffic in 1906-1907, already mentioned, and a portion of the financial embarrassments of recent years, were undoubtedly due to too great haste in seeking economies of this sort in rolling stock, without at the same time making provisions for enlargement of other portions of the plant. A more discriminating policy has consequently resulted of late. Traffic is being sorted according to its availability for concentration. The best utilization of the rails and terminals is being more considered. Business demands for quick delivery also enter into the calculation. Instead of a few huge slow-moving leviathans blocking other trains, the line may perhaps better be kept full of many smaller trains moving more nearly together. Such are certain of the details now being worked out. None of them, however, weaken the main proposition that a discriminating concentration of traffic conduces very greatly to economy of operation.
This concentration of traffic units is largely due to technical improvements of various kinds. Foremost among these has been the development of the steel rail. In 1880 more than seven-tenths of our mileage was still equipped with iron rails. Rapid progress ensued during the next ten years, upward of eighty per cent. being in steel rails by 1890. At the present time, the proportion is above ninety-eight per cent. In fact, no iron rails have been made for many years, except for repairs and on insignificant branch lines in remote parts of the country. A steady increase in the weight of the rails has ensued. The standard rail for main lines until the Civil War weighed fifty-six pounds to the yard. In the seventies this was increased to sixty-three and above; in the latter eighties the best practice was to use seventy-five pound sections. Since 1900, they frequently run as high as one hundred pounds, in regions of dense traffic. Few main lines of track now average less than seventy-five pounds. It is this increase in the use and size of steel rails which has permitted improvements in rolling stock. But, on the other hand, grave dissatisfaction with the quality of the rails manufactured of late years, particularly since the establishment of practical monopoly under the United States Steel Corporation has become manifest. Numerous accidents due to breakage of rails, especially since 1905, have revealed either defects in manufacture or an undue load imposed by heavier rolling stock, too high speed, or both. The matter has become steadily worse. In 1902 the Interstate Commerce Commission ascribed seventy-eight accidents to broken rails. Nine years later the number had risen to 249. The need of improvement is now fully recognized on all sides.
The power and efficiency of locomotives has increased, perhaps, more since 1890, and particularly since 1895, than in any previous period. Superior materials particularly have contributed to this result, such as the substitution of cast steel for cast iron and of nickel steel for wrought iron in axles, crank pins, etc. Some of the improvements which may be mentioned are, for instance, an increase in the average heating surface from 2,000 in 1890 to nearly 3,000 square feet at the present time, and an increase in the average steam pressure from 160 pounds to 210 pounds per square inch in the same period. The maximum weight has also increased very rapidly. The average weight of a locomotive at the close of the Civil War was approximately 90,000 pounds. This has increased in somewhat the following proportions: To 1881, 102,000 lbs.; to 1893, 135,000 lbs.; to 1895, 148,000 lbs.; to 1898, 230,000 lbs.; rising in 1900 to 250,000 lbs. Passenger locomotives since 1892 have almost doubled in weight, and freight engines have more than done so. Compound and double or Mallet locomotives are also supplanting those of simpler type for peculiarly heavy service. The first compound engine was built in 1899, only one being constructed in that year. In 1900 a single locomotive works turned out 500--a number constituting two-thirds of the entire output of that company--for use in the United States. Such locomotives cost more in first instance; but the greater weight and steam capacity, together with the considerable saving in fuel, amounting to perhaps twenty per cent., more than offset this objection. The traction efficiency of these improved locomotives may be shown by the statement that in 1885 the decapod Baldwin locomotives, made to haul 3,600 tons on a level, represented the maximum capacity. Five years later the same company built locomotives to haul 4,000 tons, not only on a level, but on any ordinary grade. As indicative of late advances in locomotive construction, we may instance those built about 1900 for the Illinois Central and the Union Railroad at Pittsburg, both low-grade roads, carrying exceedingly heavy train loads. The first of these weighed, including its tender, 365,000 lbs., the Union Railroad consolidation engines weighing 334,000 lbs. Such locomotives are stated to be twice as powerful as the best which were manufactured twenty-five years ago. This record is surpassed by engines which have just been built for pusher service on the soft-coal Virginian Railway. They are of the Mallet type, weighing 540,000 pounds; with a train capacity of 4,230 tons. The evaporative surface is 6,760 square feet. As summarizing the increased efficiency of American locomotives, we may instance the figures of the Interstate Commerce Commission, showing the average performance of locomotives for the United States. Whereas in 1894 the average number of tons of freight carried per locomotive was about 32,000 tons, this rose to 46,000 tons in 1899, and to 54,600 tons in 1906. At the same time the number of tons of freight hauled one mile for each freight locomotive in the United States increased from 4,000,000 in 1894 to approximately 6,000,000 in 1899, and to 7,300,000 in 1910. In other words, the average performance of each freight locomotive in the United States has increased by more than fifty per cent. in the last decade.
The economy of large freight cars has been amply demonstrated. Marked advances in the average capacity have taken place in the last few years. In the sixties a 15,000 pound freight car represented about the normal capacity. This has increased, as measured by maximum load, to 28,000 pounds in 1873; to 40,000 pounds in 1875; to 60,000 pounds in 1885; to 70,000 pounds in 1895; while at the present time 80,000 to 100,000 pound cars are in everyday use. Cars of this latter type, built to carry forty to fifty tons, are necessarily of pressed steel construction, and are mainly useful for the carriage of coal and ore and similar low-grade commodities. It seems to be questionable whether a maximum capacity has not been about reached, in view of the exceedingly great wear and tear imposed upon track, bridges, etc. Up to this point the economy of heavy loading is indisputably proved. Increased size of cars far more than proportionately increases the paying load. Thus, for instance, an 18,000-pound car will carry 20,000 pounds load, while a 22,000-pound car will carry a load twice as great. It is stated on good authority, for example, that a car of forty tons capacity can be built which will weigh but 3,000 pounds more than a thirty-ton car, and cost hardly fifty dollars more. This is undoubtedly the reason why at the present time the average load per car is at least one hundred per cent. greater than the maximum which was possible twenty years ago.
A steady increase in the freight performance of American equipment is shown by official data of the Interstate Commerce Commission. Whereas in 1894 it required on an average 1,888 freight cars for every 1,000,000 tons of freight transported their capacity has so increased that the same amount of traffic in 1906 was carried by only 1,127 cars. In other words, an enormous increase in the freight service had been attained. On the other hand, the actual mileage performance of much of this equipment is extraordinarily low. It averages only about 9,000 miles annually or an equivalent of thirty miles a day. At a speed of fifteen miles an hour, this means that actual movement under a paying load, allowing for one-third of its journeyings empty, occupies but little over an hour and a quarter a day. The actual performance is, however, not quite as poor as appears. For, of course, this average includes the non-movement of all cars in bad order (sometimes one-tenth of the total); and also all idle equipment. This latter consideration is of great moment. Special cars, suitable only for seasonal business; and especially demurrage delays, often forty-eight hours or more, adversely affect the result. Where separate mileage records of "foreign" cars are kept, as on the Wabash system, it appears that their mileage is twice as high as for "home" cars. The difference is due to the fact that cars off their own rails, mainly are in actual demand and are kept moving. Probably the daily performance of loaded cars is not less than 150 miles. But a journey of this length, with two days' delay at each end at terminals, would bring the average down to about thirty miles. The public does not always appreciate these facts; and is often querulous. It is certain that the problem how to secure greater efficiency in the use of this equipment is as yet imperfectly solved.[61]
The discussion of the nature of railroad expenditure may be concluded by a comparison of the net effects of the developments of the last few years; that is to say, of steadily expanding costs of operation and of slowly and tardily rising rates chargeable for service on the one hand, as over against the results obtained by mechanical improvements and increasing economy of operation coupled with growth of tonnage, on the other. The average cost of transportation has greatly increased. This, according to the statistics of the Interstate Commerce Commission, is shown upon the diagram herewith by the middle curve.[62] The average cost of running all trains per mile, which had fallen from 96 cents in 1891 to 91.8 cents in 1895, rose to $1.07 in 1900, and in 1911 increased by more than one-third, to $1.54 per mile. Against this should be set the fact that while the trains thus cost more to haul per mile, their paying load has increased in somewhat smaller proportion. This is shown by the upper curve on the diagram above mentioned. For freight trains the increase has been from $1.65 to $2.89 per mile. Passenger revenues per train mile have increased less rapidly. This follows from the well-known fact that freight rates have been increased, while passenger rates have not changed for the better during this period; and also that economies in concentration of traffic are necessarily confined to the carriage of freight. The immense gain in trainloads has probably been the main element, among these, as already observed.
Among other things this diagram also brings out the effect upon revenue of the substantial rate increases after 1900, coupled with the elimination of rebate losses. It will be observed how sharply the upper curve of revenue per train mile slants upward after 1899, by comparison with the lower line denoting cost. The same thing apparently occurs again after the set-back of 1907.
The interrelation between these various factors may be more readily shown by confining our attention to the period during which a practically uninterrupted development of business ensued, thus eliminating the confusion due to the four years of depression after 1893. The data on our various charts for the years 1898-1906 demonstrate that during this period the ton mileage, measuring the freight traffic handled, has practically doubled. To transport this doubled tonnage, a growth in freight train mileage of only eighteen per cent. was necessary. This was due, of course, to the notable concentration of train loading, already described, as well as to a density of traffic per mile of line almost sixty per cent. greater. As a consequence of these economies in operation, the revenue per freight train mile has increased by about fifty per cent.; while the average cost of running all trains per mile has grown less rapidly, namely, by 42 per cent. Had we data for freight trains alone it would surely be lower than this. In the meantime during this period of eight years, the rate of return in revenue per ton mile received, remained practically unchanged.[63] From all of which it would appear that even despite all these confusing factors, the law of increasing returns, so far at least as 1898-'06 was concerned, was making itself appreciably felt.
Attentive consideration of the available figures, especially as shown by diagram on page 97, shows apparently that the various economies in operation, heavier trainloads and the like, have not since 1906 yielded any greater profit from mere operation, with the ever increasing volume of business. In other words, the increase in the margin between cost of operation and revenue per train mile,--measuring profitableness per unit of movement--has not kept pace with the augmentation of the size of that unit,--the trainload. Thus it follows, as one would expect, even making allowance for all changes in rates, wages and other expenses, that the law of increasing returns as applied to railroads, does not arise primarily from economic considerations as to mere physical operation. The law originates primarily in the fiscal conditions attaching to the heavy capital investment,--the fact, namely, that fixed charges up to a given point of saturation tend to remain constant, absolutely; but become proportionately less, therefore, as the volume of business expands. From this fact, therefore, rather than because of any marked economies of large-scale production, may it be affirmed that railroads offer a notable example of the law of increasing returns. The important bearing of this distinction will appear in due time in connection with the problem of the determination of reasonable rates. Added significance, also, is given to the relation between the cost of new capital, measured by the rates of interest on bonds and dividends on stocks, and the supply necessary to provide adequate extensions and improvements in future.
Appendix:
The subjoined chart, reproduced by the Railway Age Gazette from a bulletin of the Bureau of Railway Economics, brings out forcibly the manner in which, within the short time limits of full utilization of plant, a large increase of business can take place without a commensurate growth of expenses. The phenomenon for railroads is of course cyclical. Annually, as here indicated for 1911, the second half of the year is marked by a much heavier movement of traffic, principally, of course, the crops. But expenses never rise in proportion. This is most evident for the eastern group of roads, as here shown. This causes the net revenue curve, also, to vary much more than in proportion to the volume of traffic, in consequence.
FOOTNOTES:
[50] Illustrated by the seasonal variation of business. Vide appendix to this chapter at p. 100.
[51] Webb, Economics of Railway Construction; originally in Wellington's Economic Theory of the Location of Railways.
[52] Webb, op. cit.; originally from Wellington.
[53] Wall Street Journal, March 25, 1908.
[54] Eaton, Railroad Operations, etc., pp. 44-58.
[55] Investigation in 12th Ann. I.C.C. Rep., 561.
[56] From Report of Commission to Investigate the Postal Service, 1901, p. 220; brought down to 1906 when local disturbances in wages, other costs of operation and rates outweigh all general considerations.
[57] Between 1890 and 1910 freight ton mileage rose three times over. Operating expenses grew by about two and one-quarter times.
[58] Cf. data as to revenue per ton mile on p. 413, infra.
[59] Other data as to density on p. 413, infra.
[60] Also known as "average tons per train mile." Obtained by dividing the ton mileage by the sum of the freight and mixed train miles.
[61] Cf. Quarterly Journal of Economics, XVIII, p. 299; on per diem reform. Also, Railway Age, 1903, p. 136; 15th Ann. Rep., I. C. C., p. 79; and Circular Letters, 1901, Chicago Bureau of Car Performances.
[62] Using the right hand scale.
[63] Diagram on p. 413, infra.
IV. RATE MAKING IN PRACTICE
Evolution of rate sheets, 101.--Terminal v. haulage costs, 102.--Local competition, 104.--What the traffic will bear, 107.--Trunk line rate system, 111.--Complexity of rate structure, 113.--Competition of routes, 114.--Competition of facilities, 116.--Competition of markets, 118.--Ever-widening markets, 119.--Primary and secondary market competition, 121.--Jobbing or distributive business, 124.--Flat rates, 127.--Mississippi-Missouri rate scheme, 128.--Relation between raw materials and finished products, 134.--Export rates on wheat and flour, 135.--Cattle and packing-house products, 139.-- Refrigerator cars, 140.--By-products and substitution, 142.--Kansas corn and Minnesota flour, 143.--Ex-Lake grain rates, 145.--
The task of constructing a freight or passenger tariff is an eminently practical one. The process must be tentative and experimental. Little can be calculated in advance. Tariffs are not made out of hand; they grow. Not until a rate has been put into effect, can its results be known. The lower limit of charges, however, is more or less fixed. Obviously the rate must not be less than that portion of the variable expenses incident to each particular unit of business. This variable expense is divisible into two parts, one for loading and unloading, and the other for actual movement. The first step in constructing a tariff, therefore, is to separate these two portions of the variable outgo. General experience fixes the terminal outlay for loading and unloading at an average figure of about twenty or twenty-five cents per ton at each end of the line; that is to say, at an average of about two and one-half cents per hundred pounds as the total terminal cost.[64] Just where, above or below this average, the figure for any particular tariff will lie, depends upon a multitude of details.
This terminal expense is obviously quite independent of the length of the haul. It costs no more to load for a carriage of 3,000 miles than for one between two adjoining stations. It is the second portion of the specific costs, namely, the movement expense, which varies with the distance. This movement cost is more difficult of determination, as affected by a multitude of variable factors, such as the grades, curvature, number of stops, the size of train load, and above all, the volume of the traffic. Assuming the simplest physical conditions, one would expect the movement expense, aside from the initial cost of getting up steam in order to move at all, to rise proportionately to the distance traversed. Graphically represented, the tariff would appear somewhat as follows:
In this diagram the distances of carriage are represented along the horizontal line, A B; while the rate charged is laid off vertically. The distances A C and E B represent the constant terminal cost; while the steadily rising rates with increasing distance, due to movement expenses, are shown by the sloping dotted line C D. This chart at once demonstrates why under the very simplest physical conditions a straight mileage tariff is unscientific and unreasonable. For the constant terminal expense, spread evenly over the mileage traversed as the movement expenses grow, becomes progressively less and less in proportion to the total of the two, which constitutes the real rate. The longer the haul, the lower the ton-mile cost as a matter of necessity. As Chanute calculated on the New York Central a generation ago,[65] while the average cost per mile of hauling a ton ten miles was 4.062 cents, it descended progressively to less than one cent per mile for distances over five hundred miles. A common rule is that the rate rises as the square root of the distance, rather than in proportion to it. A hundred-mile haul represents a cost approximately only twice as great as one of twenty-five miles, instead of being four times as much. For thrice a given cost the haul may be increased nine times. The course of such a tariff with increasing distance would be represented by the parabolic curved lines on the preceding diagram.[66] The particular curve would depend upon the commodity and local physical conditions. In territory where movement expenses were heavy or operation difficult, the curve would obviously rise more rapidly. Such a mathematical tariff does not depart widely from the one traced by the heavy dotted line C D first described. The progressive decline of the per mile rate with increasing distance may be illustrated by the rough estimate of allowing two and one-half cents per hundred weight or fifty cents per ton for terminal cost, with one-half cent additional per mile for movement expenses. For a ten-mile haul this would cost fifty-five cents, or an average of 5.5 cents per mile. Were the distance 500 miles, the average cost would be only (50+250)/500 cents or 0.6 cents per ton mile.
Thus far the problem has been seemingly simple. The next step introduces new complications. Our hypothetical railway line at a point one hundred miles out, may cross a navigable river or canal, or may intersect another railway. Engineering considerations of absolute cost of operation now no longer predominate. Relative costs by rival lines enter into the case. Water lines or more direct railways compete for the traffic. One cannot even fall back upon the cost of carriage by any of these lines, either the weaker or the stronger. An entirely new principle comes into play. The alternative is presented of taking the business at a rate lower than, and out of line with, rates on general traffic, rather than to lose it to another line. At first sight it would appear that it were better to abandon the traffic than to take it for less than a fair average return or profit. This is a serious matter. The tonnage offered is large. The existence of active competition for it, is proof of its importance. Railways meet at large towns, and large towns become larger because the roads meet there. The main reason for not abandoning the traffic, however, arises from that primary fact, to which one constantly recurs, that all expenses are not alike in their nature. A concrete example will make this plain.
Suppose, for instance, the normal rate to yield a fair average return, all expenses considered, be thirty cents per hundredweight. Two-thirds of the cost of this, or twenty cents, would not cease as outgo, were this business abandoned. The rails would rust, the ties would rot, and trains would move but with lighter loads, and the fixed charges would still go on inexorably night and day. Ten cents per hundredweight will meet the variable and extra cost incident to this particular business. A fifteen-cent rate would at least repay these extra outlays. It would do more. It would contribute five cents per hundred pounds to the twenty cents outgo per hundredweight, which, without the traffic, would have to be borne in toto. Even a rate of eleven cents would contribute something to this end. For it would leave a surplus of one cent per hundredweight to lighten the other burden. Adopting Hadley's phraseology,[67] if you take at eleven cents, freight that costs you thirty cents to handle, you lose nineteen cents on every hundredweight. If you refuse to take it at that rate, you lose twenty cents on every hundredweight you do not carry. For your constant expenses go on, while the other road gets the business. There is only one course open. The rate at the competitive point must be cut; if not to make a profit, at least to stop a greater loss. And one comfort may be uncovered in so doing. The lowered rate may so stimulate new business and enlarge the volume of traffic, that it may be handled at much lower cost. In fact, this consideration alone in absence of all competition, may induce a lowering of rates at certain points out of line with the general schedule. This incentive, conditioned by the fact of increasing returns, is always in the background. The destiny of many places is manifested in terms beyond the control of the carrier. Soil may be poor, climate or population adverse to progress. But some particular places enjoy peculiar advantages for growth. Not to stimulate new business at these points where traffic might be cultivated, even without rivals in the field, is little better than allowing it to escape over a competitor's line of rails, were they present.
Cutting the normal rate at competitive points or at important points in order to stimulate traffic, in conformity with the principle above stated, transforms our tariff diagram as shown herewith. The rate rises steadily with the increasing distance from A, except at E and F. At these points it is fixed at a lower point, determined not primarily by the cost of service at all, but by the available demand for it. Traffic at these points is charged what it will bear; not as much but as little as it will bear: which, being translated, means that the charge is set as high as possible, still holding the volume of business constant, or even increasing it if that can be accomplished. The total profit is constituted of the profit per unit of freight multiplied into its volume. The centre of interest is here shifted from the average profit per unit considered alone, to the total profit thus obtained. At this point another difficulty presents itself. Although, as set forth elsewhere, local discrimination,--charging a lower rate for a more distant point,--may sometimes not only be not injurious but actually beneficial to all parties concerned, it is the exception, not the rule.[68] Ordinarily to accord a remote point a lower rate without patent cause, is an economic anomaly, and, moreover, a political blunder. It violates the democratic principle of cost of service as underlying rate schedules. Most legislative bodies have prohibited it by law. The United States and most of the American commonwealths do not permit it, other than in exceptional cases. The result is that on our hypothetical tariff, the rates from A to points intermediate between A and B and B and D must be cut to the levels, E and F, fixed for those latter places. Such was the action taken by the trunk lines in 1887 in conformity with the requirements of the long and short haul clause of the Federal Act to Regulate Commerce. An original progressively rising tariff is thus at once transformed to a series of level grades or platforms, the shifts of level corresponding to the location of large towns or competitive centres; and the grade of each platform being fixed by the rate determined under competition at those points.[69] This ascending series of grades may be most irregular, as conditioned by local circumstances. The general steepness of the gradation is low on eastern roads like the New York Central, with a large volume of traffic and easy operating conditions. On western lines like the Denver and Rio Grande, in rugged territory, with a sparse population and light tonnage, the per mile rate rises rapidly and the gradation of the general tariff is steep. But always it will be found that the changes in rates occur at competitive points, with transition to a new level of rates determined by the conditions at the next competitive point beyond.
An important fact concerning this tariff thus far developed, is that, of course, the height of the upper level at the most remote point must never exceed what the particular traffic will bear. In other words, supposing that the traffic consist of grain or coal, not more than a certain amount could ever be charged, no matter how great the distance, without so far diminishing the profit in the transaction as to render the business impossible. This is shown by the diagram opposite the next page, whereon it appears that each commodity, coal, wheat, cement, lumber, or oil, having attained a certain level of rates, never rises thereafter, no matter what the distance. Each attains the maximum of what it will bear. That level it can never exceed. This immediately leads to another consideration. No single tariff is applicable to any large number of commodities. Each one must be regarded as a law unto itself. Not only does the ultimate amount which each is able to bear depend upon the value of that commodity, but also the conditions determining competition with respect to it must be different all along the line.[70]
Thus it appears that the height of the extreme upper level in our diagrammatic series of rates is fixed by the highest charge which that particular traffic will bear.[71] Beyond a certain point, no matter how great the distance, the rate cannot be increased above this level. This maximum varies, of course, with each commodity. On cotton it may be fifty-five cents per one hundred pounds; on grain or coal it will be much lower, and on sand or cement lower still. The problem of the traffic manager is to attain this highest rate as speedily as possible with increasing distance, and to grade his rates with distance up to this level as quickly as possible, consistent, of course, with maintenance of a full volume of business. But not only may the final limit of what the traffic will bear be different for each commodity; the steps or stages by which the rate progresses up to this maximum, are quite independently determined. The actual tariffs of local class rates in general are much simpler than the commercial conditions of rate making often warrant. Probably the major portion of tonnage on American railways moves under special or commodity rates. Even in Prussia over three-fifths of the traffic is of this exceptional sort. These special rates are made with a view to particular circumstances prevalent at the time. Bids from a quarryman in Vermont on stone for a public building in Chicago, may be dependent upon the grant of a low rate on his marble in competition with a quarry in North Carolina, also able to supply the particular stone required. The various ascending series of rates are thus rendered bewilderingly complex. This is also shown by the foregoing diagram of rates between St. Paul and Chicago.[72] The rate on a cheap, heavy commodity like coal, probably rises rapidly at first, and soon attains a maximum beyond which it can never go. On this diagram, for instance, the freight rate on soft coal for points up to 180 miles out is lower than that on flour. Beyond that point the coal rate in turn exceeds that on flour. Cement is higher than lumber for the first 150 miles; but after that point the relatively greater value of lumber holds it steadily above cement. On heavy cheap commodities the relatively high cost of cartage in competition enables the railway to reap the full measure of its advantage and to charge well up to the maximum of what the traffic will bear, within a comfortably short distance. Furthermore, variable costs for terminal charges have to be considered. Wherever they are high the rate must rise at once sufficiently to cover these, no matter how short the distance; but thereafter the rate may not need to be increased greatly for some time. On light higher-grade goods the wagon is an effective competitor for longer distances.[73] Moreover, the competitive points at which rates rise from stage to stage are seldom the same for all classes of goods. A river crossing brings competition for coal, lime, or cement, but does not affect the rates chargeable on high-class freight which seldom goes by water in any event. A railway specially interested in the development of some particular industry, wherever it crosses our hypothetical line, effectively holds down the rate on the product of that business. Junction points with other railways having no such interest may have no influence upon that rate, but may cause modifications in other directions. Another railway being in need of back loads over its line, as the result of a predominant movement, let us say, of beef cattle at certain seasons of the year, may introduce competition in all the tonnage capable of being carried on cattle cars. Such a road holds down the rates on this traffic wherever it happens to cross, but has no effect upon any other rate. Thus it comes about in practice, as the last diagram well illustrates, that the tariff lines cross and recross one another, generally rising with increasing distance, but at all sorts of different times and places.
Few generalizations are possible in this connection. Rate making must in a growing country ever be a matter of infinite detail. It is generally true, however, that beyond a certain point the tariff on different grades of commodities will separate more and more widely with increasing distance. For, obviously, after the low-grade goods have reached the maximum which they can bear--and this they tend to do speedily--they must remain practically constant; while those of higher grade continue progressively rising. And for very short distances the rate on the low-grade goods may even exceed that imposed upon higher-class tonnage. The coal rate for a ten-mile haul may exceed that upon some commodity worth twice as much; but for a 200-mile haul the coal rate may be only one-eighth of the rate on the other goods. Long experience on the part of the carriers has, however, enabled them to arrange their tonnage in classes; for each of which the conditions are more or less uniform. By reserving the exceptional traffic for special treatment under commodity rates, a fairly consistent scheme of charges, rising by stages with increasing distance may be evolved.
Few standard railway tariffs in the United States develop beyond the point covered by the preceding paragraph. Many of them are unable even to reach this stage of logical growth. In the South, for instance, they have never got beyond the stage of progressively rising local rates, with independent and often radically reduced charges at all large towns or competitive points.[74] Each traffic manager, particularly since the effective prohibition of working agreements between competing lines by the Trans-Missouri Freight Association decision of the Supreme Court in 1896, has been left to work out his own salvation, not aided by, but in spite of, the efforts of his rivals. There is, nevertheless, one example of further development in the so-called trunk line territory, lying east of the Mississippi and north of the Ohio and Potomac rivers. Conditions here, in general, are most favorable by comparison with the West and South. Both population and traffic are dense, and the state legislatures are conservative in making grants for the construction of new lines. The companies are historically mature. The good fruits of coöperation had already appeared in the evolution of a scientific and logical scheme, long before such coöperative action had been frowned upon by the law and the courts. All the railways in trunk line territory have worked in harmony, so far as general classified local tariffs are concerned--however much they may have fought one another over differentials to seaboard cities, or export and import rates. Their system is comparatively simple in principle, although it has required the experience of many years to work out in detail. Fully described elsewhere,[75] it will suffice for present purposes to say that all rates from intermediate points between Chicago and New York, are fixed at a definite proportion of the Chicago-New York rate both for east-and westbound shipments. Thus, for instance, as shown by the map of trunk line rate distribution, at page 365, the rate from Detroit to New York is seventy-two per cent. of the Chicago-New York rate. The percentages from the following points are as indicated, namely: Cincinnati, eighty-seven per cent.; Indianapolis, ninety-three per cent.; Grand Rapids, ninety-six per cent.; Peoria, Ill., one hundred and ten per cent.; Louisville, Ky., one hundred per cent.; Milwaukee, one hundred per cent.; and even points in Canada, such as Toronto, seventy-eight per cent., etc. Every place, no matter how small, has a certain percentage of the New York-Chicago rate assigned to it. This rate changes with any variation of the standard or basic charge. Thus when the Chicago-New York rate, first-class, is seventy-five cents, the rate from Indianapolis is ninety-three per cent. of that figure. Any change of Chicago-New York first-class rates modifies every intermediate rate in exactly the same proportion. This was well exemplified in the rate wars of 1893. These percentages have been fixed after a long process of compromise among conflicting interests. Another point of special interest is that these rates are adjusted on the basis strictly of the long and short haul principle, namely, that all intermediate points enjoy a somewhat lower rate than the terminal points, although the percentage may not be exactly upon a mileage basis. Consideration of the distribution of these percentages points to many apparent inequalities in the adjustment; but, as a matter of fact, it will be found that the existence of competing routes, of water transportation or of other factors, offers a partial explanation in most instances.
Such being the general character of this comprehensive trunk line system, the relation of it to the tariffs described heretofore is not difficult to demonstrate. Each separate railway having developed a well-ordered rate schedule, they have all met and agreed upon a unified scheme; which as far as possible harmonizes all conflicting interests. The gradation of rates rising with increasing distance from New York on each separate road, is adjusted to the corresponding gradation of rates of its neighbors on either side. The result is a series of rate zones, lying more or less concentrically about the terminal point. These zones are highly irregular in width and area, but possess one feature in common. Each remoter zone is one stage higher in rates than its predecessor. This relationship is indicated by the cross section diagram herewith. This cross section, of course, differs from the diagrams heretofore shown. It is purely geographical, being taken, not along one single railway but as the crow flies--straight across the whole trunk line territory. But in order to appreciate the significance of this elaborate scheme, one should imagine a whole series of such progressively rising rates, radiating out along the different lines of railway. Connecting the corresponding levels or stages upon each one with those of its neighbors, the concentric zones are immediately outlined. The advantage of such a broad scheme is that it generalizes the single line tariff; taking into view every place, no matter how small and irrespective of its location whether upon a through line or merely a local transverse one. Every town, no matter how insignificant, is assigned a place in a logically evolved plan. Such would seem to be the ideal of rate construction, toward which all traffic managers should strive.
* * * * *
The foregoing description of the development of a mileage tariff is applicable to only a part of the traffic. A very large volume of tonnage,--said to be not less than seventy-five per cent. in America, sixty-three per cent. in Prussia and fifty per cent. in the United Kingdom,--moves under special rates made in quite another way in response to the exigencies of commercial competition. The making of these freight rates in practice is an extremely complicated matter. No single road is independent of rates made by its rivals--rates applicable not only to competing commodities and markets, but also as affected by apparently the most remote and disconnected contingencies. Thus railway rates, as has well been said, are not a set of independent threads; they form a fabric. They are so interwoven everywhere that if one thread be shortened, it will cause a kink in the fabric that may run almost anywhere. In order to understand this it will be necessary to describe somewhat in detail the nature of competition as applied to transportation; and then to show by a few concrete illustrations, the various factors which actively enter into the determination of specific rates. Laymen and legislators do not sufficiently appreciate the extremely delicate nature of the work. Much discussion relative to railway competition seems to be based upon the assumption that it consists in the main of the competition of railway lines more or less parallel or else operating under substantially like conditions. As a matter of fact competition in transportation is to a large degree far more complex.
Railway competition is of three entirely distinct sorts. These may be denominated, respectively, competition of routes, competition in facilities and competition of markets.[76] The first of these, competition of routes, as the name suggests, is limited to the activities of the carriers alone. It occurs whenever two railways are exposed to identical commercial conditions both at the point of origin and of destination. The rivalry is direct and physical. The only competition possible is that concerning the route by which traffic may move between those two points. Such competition is most likely to arise between more or less parallel lines, as for instance between the various trunk roads from New York to Chicago. The classic instances in our history are of the rate wars due to the West Shore and the Nickel Plate, which were built for the express purpose of engendering competition with the then existing lines,--the New York Central and the Lake Shore, respectively. The same sort of simple competition prevails, of course, between a railway and a parallel canal or other waterway, as, for instance, between the Erie canal and the trunk lines, or the Illinois Central and the Mississippi river. Such simple competition as this, where confined to railways alone, almost inevitably leads to one of two results: the roads may remain independent, preventing ruinous rate wars by pooling; or else, as a result of long continued cut-throat competition, the bankrupt road may be bought up and merged with the solvent one. This was the fate of the old New York and New England railway, finally purchased by the New Haven system; of the West Shore and Nickel Plate lines; and of the Kansas Pacific, unloaded on the Union Pacific by Jay Gould. The nature of railway competition is indeed such that no other result than consolidation or pooling can ensue. Weyl is right in his observation that,--"Strictly speaking, permanent competition can exist, not between railroads struggling for the same traffic; but solely between those railroads which have no territory in common."
This first form of competition of routes or, as it has been called, of alternative routes, often obtains where conditions of competition are more obscure than in these simple instances above named. In the rivalry for the imported plate glass or crockery traffic between the trunk lines and the Gulf roads, the competition is none the less of routes between Liverpool and Chicago, although the water carriage by way of New Orleans or Galveston is so much more roundabout. Freight actually moves from Boston to Chicago by a line 1786 miles long, via Asheville, N. C., while the direct distance is only 1004 miles.[77] From St. Louis to Meridian, Miss., is 512 miles by direct rail line; yet traffic may move over 2000 miles going to New York and then around.[78] The map on p. 271, showing the various rail and water lines concerned in traffic between New York and the little town of Troy, Ala., shows how widespread are the ramifications of competition of this sort. Manifold instances of such roundabout carriage have been elsewhere described in full.[79] They differ from the competition of parallel routes, however, in the important regard that absorption of the long lines by the short ones becomes both physically and financially impossible. Whenever a large area like the Pacific slope is devoid of manufactures, and wherever the source of supplies is sufficiently concentrated, as, for instance, in the manufacture of agricultural implements which are almost exclusively made in or about Chicago, we still have to do with a clear case of competition of routes, although a great number of carriers may participate in the business. When molasses or rice are only to be had from New Orleans, the centre of such business, the carriers to all tributary consuming points compete for the routing of it over their own respective lines. These carriers may operate either by land or sea or by a combination of both; and they may transport commodities by the most roundabout ways.[80] The determinant feature, however, distinguishing this class of competition is neither the mode or carriage nor its length; but is found in the fact that the commercial conditions at both ends of the line, points of origin and destination, are identical for each participant in the business. Direct competition of routes, therefore, has to do with pure transportation,--the creation of place values,--and this being the case, the relative cost of service is always a factor of moment.
Competition of facilities, the second of the three phases of railway competition above mentioned, deals, as its name implies, not at all with the rates charged but with the facilities or conveniences afforded. Such competition is confined solely to rivalry for business at the established rates. Immediately on the appearance of any departure from these conditions the question becomes one of competition of either of the other two sorts. An instance of competition of facilities would be the introduction of reclining chairs or of a superior service in passenger business. When the Rock Island system offered such facilities without an extra charge, it became necessary at once for others to meet this competition in the same way that they would meet a reduction of rates. Any reduction in time of transit for freight business between two given points without extra charge, would in the same manner give rise to competition of facilities. Such facilities, however, as might have a distinct money value, as, for instance, free storage, cartage, demurrage or milling-in-transit, any one of which practically amounts to giving value without charge, are, of course, equivalent to a reduction of the rate; and do not belong in this class of considerations at all. Only those conveniences or facilities, which, while attempting to secure business may not be compounded for money, should be classified in this group. It should also be observed that competition of facilities may as readily arise between parts of the same railway system or under pooling agreements to maintain rates, as between distinct and independent companies.[81] And such competition between parent and child often arises. Thus, for instance, business was as actively solicited as ever by the Pennsylvania and the Baltimore & Ohio in competition during the several years of financial control of one by the other prior to 1907. The New Haven railway may compete with its own water lines around Cape Cod or on Long Island Sound. But in all of these instances the cardinal feature to note is that the competition is always at the established rate. For New England, although the New Haven system and the Boston and Maine do not compete on rates at their points of contact, there is constant rivalry in respect of facilities or service. The same thing is undoubtedly true of the Atchison and the Southern Pacific in the carriage of California fruits. Although operated under pooling agreements, yet they were competitors in the matter of the service offered. Each sought an enlarged volume of tonnage, but not by cutting the agreed rate.
The third form of competition in transportation is dependent upon the competition of markets; and is not in reality direct competition between carriers at all. This is the most difficult of all forms to understand.[82] It is certainly in many cases more than a "euphemism for railway policy."[83] Yet although indirect and often obscure, it is of fundamental and conclusive importance in the determination of freight rates. Commercial competition deals not with a mere choice of routes, but with alternative markets. The carriers act, not independently and of their own volition, but only as agents or representatives for their constituents, the shippers. They may become tools or weapons in the hands of merchants or manufacturers who are the real contestants. It is largely in this sense that it is so often alleged, and rightfully, that railway traffic managers oftentimes do not make rates at all. Their energies are bent to the analysis of those circumstances by which their rates are made for them.
The production or preparation of commodities for final consumption falls naturally into two distinct parts; the creation of form value, succeeded by the conferring of place value. Transportation is concerned alone with the latter process. Of these two operations, the latter, the creation of place values, is by far the more elastic and adaptable process. The grower, the miner or the manufacturer has his first costs more or less rigidly fixed by natural or human conditions; such as the fertility of the soil, the grade of ore, the prevailing scale of wages, and so on. His proximity to the status of a marginal producer depends upon his relative position in these respects. With the carrier, matters are more contingent. Including within its reach, as it does, many grades of producers and consumers, each more or less rigidly held bound by his own circumstances and conditions, as above said, the carrier is able to exercise a wide range of choice in fixing that margin of value created which it reserves for itself. And at all times, by reason of the factors set forth elsewhere, primarily its subjection to the law of increasing returns, this intermediate share of the carrier tends to adjust or accommodate itself to the end that it may discover or produce a wider margin between values in the hands of producer and consumer, respectively. This may be best accomplished by a progressive widening of its field of activities, that is to say, by an enlargement of its physical reach and scope. It is always striving to lower the cost of production made by the marginal producer. Its motto must ever be, to get more business, if not right at home by search for it abroad--and this always with the chance that the greater the distance between the producer and the consumer, the greater the possible margin of place value remaining as its individual share.
This ever-present incentive to widen the market carries with it a direct consequence. A market is a commercial area characterized by a prevalent equality of prices. Phenomenal development in this respect is characteristic of the United States. For many commodities the market is coextensive with the national domain. It is the chosen function of transportation agents, by rail and water, to ensure this result; to preserve an equality of prices, despite the variety of producing and consuming conditions. The railway is the agent by which the market is thus widened and rivalries are thus equalized. In railway parlance this is what is known as "keeping everyone in business." The following quotation from the Senate Committee Hearings of 1905 adequately describes the process: "I am interested in the erection of a mill that has just been completed, and sometime since I was figuring on the question of a smokestack. I wanted to have that stack built out of brick that is burned in New Jersey, and that is several hundred miles away. It is a long way to ship freight from New Jersey to North Carolina. A quotation was made me by the stack builder, whose office is in New York, and I remarked to him, 'That price is prohibitive; I cannot pay that price for that stack.' He said, 'That is the best I can do; but if you will tell me what you can afford to pay for that stack, in competition with home-burned brick, I will see what I can do with the railway people.' He said, 'All right; I will take it up with the railway people.' His quotation included the delivery of the brick and the erection of the stack at my plant. It would require something like about fifty carloads of brick to build that stack. Within a week he had his price revised, and gave me a satisfactory quotation and took my contract for the stack. Of course he had to get a special rate from the railway people, because there is no regular tariff on brick from New Jersey to North Carolina." In this instance the railways actually created this new business by so adjusting the margin between the minimum cost of making brick in New York and in North Carolina, as to make it possible for the traffic to move. The special rate here mentioned, however, should be carefully distinguished from a secret rebate offered to one contractor as against another in the same place. This commodity rate, while special to meet a particular contingency, was open to any other shipper similarly circumstanced. The student cannot too carefully discriminate between these two sorts of special rates. They are constantly confused in the public mind. The effect of these open commodity rates, is not to create difference of opportunity between individuals, but to generalize economic conditions and equalize prices throughout wide areas.
The most satisfactory way to describe commercial competition as applied to carriers is by concrete illustrations. There are two distinct varieties or degrees of it, which may be denominated primary and secondary. These might as properly, perhaps, be called simple and complex, or direct and indirect. Of these, the first concerns those cases wherein a commodity undergoes no physical transformation between producer and consumer. Shipments are usually direct. Only one rate is involved. Shall St. Louis and the South, for example, be supplied with salt from the Kansas or Michigan fields?[84] This is a case of pure transportation,--the creation of place value, alone. The Aroostook farmers of Maine compete in prices with the potato growers of Michigan in the New York market. Each district is usually represented by a railway, dependent upon the prosperity of its particular constituency. Competition of markets is usually more keen where a number of carriers are concerned, each representing its own clients; but it may conceivably arise as between several markets served by the same company, especially with the growth of great railway systems. The Southern Pacific must insure a rate from California on oranges to eastern markets, as compared with the rates over the southern roads from Florida, sufficiently low to warrant the venture of capital in the industry.[85] Marble from the quarries of Vermont and North Carolina, and paving blocks from the Lithonia district in Georgia and from Wisconsin or South Dakota, must meet in Chicago on even terms. Such competition, although simple and direct, recognizes no national bounds. Copper from Montana must be laid down in Liverpool at rates to permit of meeting the price on Chili bars from South America. Our entire grain and cotton crops must be transported at rates which will enable them to hold their own in European markets. The California raisin has, in this manner, had to make its way into Eastern markets in the United States against the pressure of importations from Spain, as described in another place.[86] The cotton mills in New England and in the South must have their output carried to China under conditions which will enable them to meet the price made by the British manufacturer. This last instance, however, introduces us to the second form of competition; inasmuch as a double transportation is involved first from the fields to the mill, and thereafter from the mill to the consumer.
Secondary or indirect forms of commercial competition in transportation, concerning, as has been said, not one but two distinct carriages of entirely different goods, needs to be in turn subdivided still further. The products of agriculture and mines afford the best instances. The lumber business is peculiarly suggestive in this connection, owing to the fact that in the United States a vast treeless area in the Middle West is surrounded with forest tracts available for development. The market again in this case is limited only by our national frontier. Omaha is supplied with yellow pine and cypress from Louisiana after a 1,200-mile haul; Oregon fir brought 1,800 miles in each instance for fifty cents per hundred pounds; and with Michigan hemlock and pine transported less than 500 miles for eleven and a half cents. These various sorts of lumber are all more or less competitive. And in each case the final cost of laying down the product in Omaha is determined; first, by the rate from the stump to the mill, and then, as sawed lumber, thence on to destination. The Eau Claire, Wisconsin, lumber case[87] before the Interstate Commerce Commission, fully describes the intricacies of adjustment needed to hold a number of such producers on a parity. In this instance Eau Claire, "next the stump," as an important lumbering centre was shown to be declining in importance relatively to Mississippi river towns, which received their logs by raft down stream. A differential of a few cents was threatening the welfare of a considerable population. The Wichita, Kansas, cases are suggestive in a similar way.[88] Sugar is laid down at this market from every point of the compass. From Hawaii it is shipped in the raw state to San Francisco, and then brought East, like the Oregon lumber, cheaply, as a back-load to counter-balance westbound shipments of grain and manufactures. From New Orleans refineries comes the Louisiana product, and from the Atlantic sea ports the Cuban sugar; but in each case the carriage is broken at an intermediate point, at which manufacture or jobbing ensues. A large class of operations analogous to this, known as "milling in transit" and "floating cotton," elsewhere described in detail, involve the same complexity and interrelation of rates.[89] The point to carry forward is that commercial competition demands that in every case not single rates but the sums of all the connecting rates for each competing person or region shall be properly adjusted. If this be not done, some one will be excluded from the market and "put out of business."
By this time in our ascending scale of complexities, it will be observed that manufacture now begins to outweigh mere transportation in importance. With low-grade products, like salt or sugar, the increment of value due to transportation is relatively high as compared with manufacturing costs. As the grade of product rises, however, the differences in value and in form between the raw and the finished product, render the problem of location of the manufacture more difficult as affected by the relative adjustment of rates of transportation for the two. According to the data of the Federal Bureau of Corporations, the cost of refining crude petroleum, worth three to four cents a gallon at the wells in Pennsylvania, should not exceed one-half cent a gallon. This sum would barely pay for the first hundred miles of its carriage by rail, as ordinarily shipped. The market is, of course, extraordinarily extensive; hence the persistent flagrancy of the practices of secret rebating by the Standard Oil Co.[90] To obtain such special favors in transportation outweighed in importance the incentive to introduce economies in production. In this industry, where little waste occurs in manufacture, the refineries may well be located at the consumers' door. The manufacture of furniture for the Pacific states, on the other hand, must be located "next the stump," in North Carolina or New England. The long carriage must be applied, not to the bulky lumber but to the finished product. The freight rate on lumber from Oregon to Pittsburg is just about equal to the value of the logs at the mill. Obviously, the large proportion of waste or common lumber will not bear a high addition to its cost by carriage to any distance. In the manufacture of fur hats a shrinkage of weight occurs of one-half between the fur scraps and the finished product. In such a case it is imperative, either that the factory be near the source of supply or that the rate on the two distinct commodities be nicely adjusted. The decision of the United States Steel Corporation to build a large plant at Duluth for supplying the northwestern market is the outcome of such considerations. The main point is that the adjustment of a number of rates may determine, not only the general welfare of the industry but even its specific geographical location with reference to the raw material on the one side and the market on the other.
The jobbing or wholesale business of the United States exemplifies the most highly involved and complex details of commercial competition.[91] In this field it appears most clearly that, as is so often alleged, railway traffic managers hold the welfare of entire communities, as it were, in the palms of their hands. In all the cases heretofore cited, great natural forces outweighed the purely personal and human ones. Soil, climate and mineral resources more or less completely determined the final outcome of commercial competition. But the distributive business of a country is more largely artificial. It is more subject to human control, and may be influenced by personal considerations. Shall the economically dependent southern planter be supplied with manufactures of all sorts,--from harnesses to tin dippers--from mid-western cities like Cincinnati and Chicago or from eastern centres, such as New York and Baltimore? This is the underlying economic issue raised in the notable Cincinnati Freight Bureau Case in 1894; in the course of whose determination the Supreme Court of the United States raised the more immediate and pressing question of the authority of the Interstate Commerce Commission to regulate rates at all. In the dust raised by the controversy over this purely legal question, the basic economic dispute was lost to view.[92] Shall the people of the Pacific slope be supplied with hardware and analogous products from their own large cities which buy at wholesale from the East, break bulk at San Francisco or Seattle and ship out to smaller towns in less than carload lots; or shall the distribution take place at the hands of jobbing houses located several thousand miles away at Chicago or St. Louis? This is the economic dispute raised in the St. Louis Business Men's League case.[93] The very existence of San Francisco as a commercial centre may depend upon it. For the primary and secondary operations of commerce are often complementary. At the large cities, concentration of raw staples moving inward naturally entails back loads outward at low rates for manufactured goods distributed by jobbers. Or, taking the smaller places, the farmer will of necessity buy his cotton cloth, sugar and coal in the town to which he drives by wagon to deliver his cotton, corn or wheat.[94]
The entire puzzling class of cases dealing with the southern basing point system are primarily concerned with such issues as these.[95] Three distinct classes of cases arise. There is, first, the competition between cities of equal size, be they large or small, such as Memphis, Tenn., and Little Rock, Ark.; Danville, Va., and Lynchburg; or Cleveland, and Cincinnati, Ohio: secondly, the rivalries between large cities and what may be called secondary local centres in the same part of the country,--such as Seattle, Wash., v. Spokane; Chicago v. Burlington or Dubuque, Iowa; or Atlanta, Ga., v. Macon: and thirdly, the intense rivalries between the great first-class cities, like New York, Philadelphia, and Chicago, and the rest of the field, big and little.[96] The mail order houses, the express business and the parcels post intervene at this point. But in all of these issues, series of no less than three separate transportation costs have to be totalized and kept more or less on a parity. The intricacy is increased by reason of the fact that shipments must be made, first at wholesale to the jobbers, and thereafter usually in less-than-carload lots to retailers. If the carload rate be relatively too low, with reference to the rate on small lots, the jobbers near the market will be upbuilt and the jobbers at a distance cannot compete. If the opposite relation obtains, the jobber in a distant great city will be able to ship out small orders cheaper than the local dealer can obtain them by carload and, breaking bulk, peddle them from his own town. So narrow is the margin of profit on staple goods that a difference of a fraction of a cent per pound may exclude a dealer from the field entirely. This question of carload ratings is, however, treated elsewhere; impinging, as it does upon matters of freight classifications.[97]
The rivalries of jobbers and middlemen in different cities are inevitably borne into the offices of traffic managers. Were all railways equally interested in all cities alike, the matter need not go further, engendering railway rivalries. But such is seldom the case. Hardly a road can be named, whose interests are not more or less identified with some particular city. Commercial rivalry thus at once leads to railway competition. Four or five railways, like the Chicago and Northwestern, radiate out to the west from Chicago, and have no interest in St. Louis. Almost as many, like the Missouri Pacific, go out from St. Louis without entering Chicago. Others, like the old Union Pacific and, formerly, the Atchison system, only come to the Missouri river, and consequently wish to upbuild their eastern termini, Omaha or Kansas City. Only a few, like the Illinois Central, reach them all. Such a road is usually called upon to act as a mediator in all disputes. "It is a continual struggle between the line from Kansas City to St. Louis with no interest in Chicago, and the line from Kansas City to Chicago with no interest in St. Louis," as one witness before the Industrial Commission phrases it. Compromise is the only outcome. And in this manner an involved structure of differentials is built up, oftentimes top heavy and always susceptible of collapse on the defection of any party to the agreement. When a truce was patched up between the trunk lines and the Gulf roads after the sugar rate war of 1905, it is said to have taken twenty experts three entire days merely to "line up" rates on a parity between the competing jobbing centres.
The simplest compromise in any dispute over rates between competing centres is the concession of absolute equality or, as it is called, of flat rates between all points irrespective of distance. This shifts the burden from the carriers and places competition entirely upon the shoulders of the merchants. Oddly enough, also, this result of equal rates regardless of distance between various competing centres, especially when they are secondary distributing or concentrating points rather than original sources of traffic, may sometimes evolve naturally out of commercial conditions imposed by tariffs built up upon the basis of distance. The accompanying theoretical diagram, based upon actual traffic conditions prevalent in Missouri river territory, serves to illustrate the way in which, under certain circumstances, such equalization of rates may take place. Two groups of cities are here represented as though lying respectively along two river valleys north of their separation at a point G. Let us call them the Mississippi and the Missouri for purposes of identification. The starting point is equality of rates from such a distant point as New York (O) to all places along the Mississippi from A to G. Such equality properly arises in theory from the substantially equal distance from New York. In practice also, under the trunk line rate system,[98] such equality prevails, inasmuch as the rates from New York to such a series of Mississippi river crossings is fixed at 125 per cent. of the rate from New York to Chicago. By a similar course of reasoning, namely, the approximately equal distance from New York (O), rates from that place to a second series of points along the Missouri river should be and are in effect made equal. From these two facts it logically follows that the balances of the rates from all points on the Mississippi river out along an extension of their lines from New York toward the west should also be equal. This is obviously in conformity with the mathematical principle that equals subtracted from equals leave equal balances. Thus the rates B X, D Y and F Z are compelled to equality. From this relationship in turn follows still another. All rates from any point on the inner series of towns to any point whatsoever on the outer western series of places along the Missouri river must remain equal regardless of distance. For each line from New York to A, B, C, D, etc., wishes, of course, to participate in business not only on the direct extension of its own line, but to as many other points as possible.[99] Without some agreement, however, it would normally enjoy traffic only on the direct extension of its own line. The point Y would most naturally be reached by way of C, D or E, over the shortest routes. Competitors on either side would similarly enjoy an advantage in more direct lines from New York to the places immediately beyond them. Thus for business from New York to Z, the more direct lines through E, F or G would obviously have an advantage over lines which passed around through A, B, C or D. An almost irresistible incentive to cut-throat competition would exist. The only way the lines east of the inner circle can peaceably partition business to the outermost western points is by an agreement to make all rates between the inner and outer circles the same. In this manner the rates from A to Z or from G to X are reduced to an equality with the rates offered by the shortest route between the two rivers, which, in this case, is E Z. The rate for this shortest line then becomes the basic one, upon which all the others depend.
The foregoing economic reasoning underlies the actual tariff system prevailing in what is known as Missouri river territory.[100] Two great streams separating at St. Louis form the eastern and western boundaries of Missouri and Iowa. All along the two edges of these states are located important river cities, each of which has more or less direct communication with every other crossing on the other river, over a complicated system of interlaced lines. There are no physical barriers, the country being plain and open. The starting point and basis of the whole scheme is the shortest direct distance between the two nearest points, namely Hannibal on the Mississippi, and St. Joseph and Kansas City on the Missouri. The situation is shown by the map herewith. At these points the two rivers are approximately two hundred miles apart. For this distance the base rate of sixty cents per hundred pounds, first class, is fixed by common agreement. Were local business only to be considered, and were the railways not competing, the rate between other points on the two rivers at greater distances apart, such as for instance, Burlington on the Mississippi and Omaha on the Missouri, might be determined on a relative distance basis, as in trunk line territory. But the commercial fact is that a large proportion of the business between all these points consists of long-distance traffic from the eastern seaboard which may cross the Mississippi at any one of these gateways between Dubuque and St. Louis on its way to the cities on the Missouri river. All of these through long-distance shipments must, of course, enjoy the same competitive rate to the ultimate western destination on the Missouri river. And, inasmuch as the rate from the east to the Mississippi crossings is everywhere the same, namely 125 per cent. of the New York-Chicago rate, it follows that the balance of the rate from these points on to the Missouri river across Iowa and Missouri, irrespective of distance, must likewise be the same. In other words, the rates between all these Mississippi and Missouri river points must be equalized, irrespective of the length of the intervening route, whether it be two hundred miles by the shortest direct line from Hannibal to Kansas City across Missouri, three hundred and fifty miles from Burlington to Omaha across Iowa, or even seven hundred miles by the roundabout line of the Illinois Central skirting both states. In brief, every railway which touches both rivers, however circuitous its route, is compelled to quote the same rate from every point on the Mississippi river to every other point on the Missouri. This rate must be the one fixed, as already described, for the shortest direct line, namely sixty cents per hundred pounds first class. Furthermore, in precisely the same way that these rates to Missouri river points from the eastern seaboard are built up and equalized, the rates from Chicago to the same Missouri river points must be kept even. The rate through from any one of the long chain of Mississippi gateways must be the same irrespective of distance. This figure, by common agreement, has for many years been twenty cents per hundred pounds higher than the rate across Illinois to the Mississippi river gateways from Chicago alone. The dominant note of this whole tariff is equalization of rates between all points in competition with one another over all possible routes. Freight thus moves freely in every direction and all markets are held on an absolute parity.[101] It is one of the most remarkable features of American commercial organization, this practical elimination of the element of distance from interstate trade over wide areas.
The possible evil lurking in too widespread an acceptance of the principle of the flat rate is clearly apparent in the reasoning of the Eau Claire, Wisconsin, lumber case.[102] This town complained of the disability under which it labored in shipping lumber to Missouri river points by comparison with other places round about. It appeared in the evidence that as early as 1884, under arbitration, all the rates from competing centres had been adjusted on the basis of differentials; and that, as interpreted by the carriers, the purpose of these differentials was to even up the differences between competing towns; to the end that all manufacturers should be put upon an equality in the consuming territory. But this necessarily involved the practice of penalizing or nullifying in a way the advantages of location. "If Eau Claire could produce lumber cheaper than Winona or La Crosse, then the latter points were to have a lower rate in order to enable them to compete." This practice the Interstate Commerce Commission condemned at that time; and it has consistently adhered to the precedent then laid down. Obviously, any other general course of action would be analogous to hobbling the fleetest horse in a race to bring him down to the rate of progress of the slowest laggard. The principle of the handicap applied within moderate limits makes for an exciting athletic contest; but if it be overdone, it eliminates all interest from the contest whatever. The race becomes one, not of skill or endurance in running, but of securing a sufficiently liberal handicap. Competition to be of advantage in the way of progress must always have in view the survival of the fittest and the elimination of the unfit.
The vast extent of the United States, the necessity of transporting commodities great distances at low cost and the progressiveness of railway managers, has led to an extraordinary development of the phase of rate making above-mentioned. The principle of the flat rate, based upon the theory that distance is a quite subordinate, if not indeed entirely negligible, element in the construction of freight tariffs under circumstances of competition, was fully accepted twenty-five years ago.[103] J. C. Stubbs, traffic manager of the Harriman lines, speaking of transcontinental business in 1898, clearly expressed it as "the traditional policy of the American lines as between themselves to recognize and to practise equality of rates as the only reasonable and just rule ... regardless of the characteristics of their respective lines, whether equal in length or widely different." It is the theory upon which the southern basing-point system is founded; and it is the common practice in making rates into and out of New England--being in fact vital to the continued prosperity of this out-of-the-way territory.[104] President Tuttle, of the Boston & Maine, has most ably supported this principle of equality of rates irrespective of distance. "It is the duty of transportation agents," he says, "to so adjust their freight tariffs that, regardless of distance, producers and consumers in every part of this country shall, to the fullest extent possible, have equal access to the markets of all parts of this country and of the world, a result wholly impossible of attainment if freight rates must be constructed upon the scientific principle of tons and miles." This is the principle of the blanket rate attacked in the famous Milk Producers' Protective Association case in 1897;[105] and it is the practice which has been so fully discussed of late, as generally applied to lumber rates from the various forest regions of the United States into the treeless tract of the Middle West. The principle, while applied thus generally in the construction of tariffs, is of far greater applicability in the making of special or commodity rates. Wool rates afford one of the best examples. Under such rates the bulk of the tonnage of American railways is at present moved. The essential principle of such special rates, constituting exceptions to the classified tariffs, is that of the flat rate; namely, a rate fixed in accordance with what the traffic will bear, without regard to the element of cost, that is to say, of distance. But a noticeable trend away from the flat rate is evident in recent decisions of the Interstate Commerce Commission; especially in the Intermountain case,[106] revision of the wool and cattle rates,[107] and the general disposition to lessen special tariffs all along the line.
* * * * *
The intricacy of freight rate adjustment in response to the subtleties of commercial competition depends only in small measure upon the absolute freight rate imposed. The main problem is really that of relativity. But this does not mean mere relativity as between directly competing commodities or places. A strict relativity based upon commercial conditions must often obtain as well between the rates on raw materials and their own finished products; between all the various by-products in an industry; and, of course, always as between goods capable of substitution one for another. A few illustrations will serve to make these details clear.
The matter of properly correlating the freight rate on raw materials and the finished products made from them, is more far-reaching than it seems. The location and development of manufacturing depends upon it. The country may be broadly divided into agricultural and manufacturing sections. The first of these is ambitious to develop its resources; not only to feed, but to clothe itself and make other provision for its needs. No sooner does it seek to develop local manufacturing than it finds itself exposed to competition from the older established manufacturers at a distance. Sometimes, even, these remote manufacturers draw their supplies of raw material from its own fields and forests. These supplies are then shipped long distances as raw material; manufactured and thereafter returned to sell in competition with the local product. The local market in relatively undeveloped areas is probably insufficient to provide support for manufactures on a profitable scale. It is essential to dispose of the surplus product over a wider area. Thus there arise two classes of manufacturers: one "next the stump," manufacturing at the source of the raw material and desiring to ship the finished product; the other, remote perhaps from supplies of raw material, but favored by long experience, by abundant supplies of capital and of skilled labor and by other advantages.[108] Neither class of shippers can prosper without overflowing into the domain of the other. The outcome of this competition depends in part upon the policy of the carriers. If the rate on the raw material be relatively low, the remote manufacturer is aided. Cotton mills and shoe factories in New England prosper in competition with establishments in the South or the Middle West. If, on the other hand, the rate on raw materials be inordinately high, while at the same time low on outward-bound shipment of manufactures from the seat of the raw materials, the tendency is in favor of the upbuilding of manufactures, not near the historic centres of population and consumption, but near the sources of natural wealth, which are the potential homes of manufacturing.
The long-standing controversy over relative rates on wheat and flour for export affords an interesting illustration of the difficulties of properly correlating charges of this sort.[109] Originally the rates on wheat and flour--the raw material and the manufactured product--were the same. In 1890 the railways leading to the Gulf ports began to discriminate by giving lower rates on wheat, but the trunk lines until 1899 held to the original equality between the two. Finally, however, the struggle between the trunk lines and the Gulf roads for business forced the former to lower their rates on wheat, leaving the flour rates--not subject to Gulf competition--undisturbed. At times the rate on wheat for export was as much as nine cents per hundred pounds lower than the rate on flour. Thus the rate on wheat for export from the Mississippi river to the seaboard was frequently twelve cents, while the rate on wheat from the same points to Chicago added to the rate on flour there manufactured and sent on in barrels or bags to New York, was twenty-two cents--a clear discrimination against the domestic manufacturer in this instance of ten cents per hundred pounds. For his American-made flour, sent abroad in competition with flour made in Liverpool from American wheat, would evidently cost that much more at delivery. In other words, wheat could be transported to England and there ground much cheaper than it could be ground here and then shipped. This bore with particular severity upon small millers, partly because their costs of manufacture were relatively high, and also because any limitation of export business forced the large millers to bid more keenly for local domestic trade. Inasmuch as a fair margin of profit to the American manufacturer would not exceed two cents per hundredweight, it is apparent that this discrimination operated severely against the American miller. Minneapolis fortunately was unaffected by this discrimination, much of its exports going out by Canadian lines to the Lakes. The carriers defended this difference in rates on the ground of water competition by the Lakes or combined rail and water routes, which were alone open to wheat, and which thereby unduly lowered the rate on that commodity; and also on the basis of the lower cost of service in moving the raw material as compared with the finished product. It is apparent that issue was really raised in such a case between the interests of the farmer and of the manufacturer. The United States, producing a surplus of wheat the price of which is made on the Liverpool market in competition with the world, is compelled to find an outlet for this product. It is obvious that any reduction of the freight rate--the prices in Liverpool remaining fixed--would inure to the benefit of the farmer, who would thereby receive a higher price for his product. Viewed in this way the railways by discriminating in favor of the rate on wheat were helping the farmers. But, at the same time, by moving this wheat more cheaply than flour the railways were encouraging the location of flour milling abroad and rendering it impossible to manufacture flour for export at a profit in the cities of the Middle West. In these export cases it does not appear clearly why the rate on flour for export might not have been reduced somewhat. The Interstate Commerce Commission finally rendered a decision to the effect that the existing difference in rates constituted an undue preference in favor of the foreign manufacturer, adding at the same time that these discriminations seemed to be due primarily not to a desire of the railways to aid the American farmer in disposing of this surplus wheat, but to the bitterness of competition between the Gulf and trunk line railways.[110] They decided that any discrimination greater than two cents per hundred pounds in favor of wheat for export as against flour was unreasonable. This difference was permitted, however, on account of the greater cost of handling the manufactured product. It is significant of the then state of the law that the railways paid no attention to this order, and, although conditions improved somewhat, there is still great complaint.
The relative rates on wheat and flour, even when for domestic consumption, illustrate the same difficulty of commercial competition--the necessity of adjusting the rate on raw materials to that on the finished product.[111] The rate on wheat from Wichita, Kan., for example, to California is fifty-five cents per hundred pounds, while the rate on flour between the same points is sixty-five cents. Is this difference in rates economically justifiable? California wheat is soft, so that flour produced from it is much improved by the admixture of hard wheat, such as may be obtained in Kansas. California, formerly a large wheat exporting state, has of late years relied to a considerable degree upon the Middle West for part of its supplies. Kansas flour sells for seventy-five cents a barrel more than California wheat flour. Shall this Kansas wheat, to be consumed in California, be ground in Wichita or in California? Here is material for controversy, not between one particular railway and another, but in reality between the millers in Kansas and the millers in California. It is quite analogous to the issue raised over export wheat and flour between the miller in Chicago and his rival in Liverpool. In this instance, if milled in Kansas, the railways enjoy the carriage of flour; while, if ground in California, the railways carry the commodity in the form of wheat. Owing to certain practical conditions, such as the percentage of waste and relative differences in labor costs, the Kansas miller appears to enjoy a certain advantage over his far western competitors. At this point the interest of particular railway companies appears. The Rock Island, if the milling industry in Kansas develops, obtains the haul not only of the flour but also of the fuel and of supplies for the communities engaged in the business. On the other hand the Southern Pacific is more largely interested in the local development of manufactures in California. The Rock Island by maintaining a lower rate on flour than on wheat, would tend to hold its clients in the field. The Southern Pacific, on the other hand, by securing the reduced rate on the wheat from Kansas would materially advance the welfare of its constituents. Thus the rivalries of the competing localities immediately become the direct and immediate concern of rival railways.
Cases precisely analogous in principle to those concerning the relativity of rates on grain and grain products have troubled the carriers for years in respect to the rates upon cattle and packing house products.[112] A low rate on cattle as compared with beef favors Chicago today as against Missouri river points, the latter being nearer the cattle ranges; just as a generation ago it enabled cattle to be brought to New York and Boston to be there slaughtered and sold on the spot. The history of this controversy throws much light upon the difficulties of rate making in practice. Originally the railways encouraged cattle raising by a rate which was only about one-third of the rate charged for beef. Slaughtering was carried on in the East adjacent to the great markets. To this policy the western packers objected strenuously. They demanded a relatively low rate on their finished product in order to enable them to bid against the local eastern slaughter houses. The stockmen, on the other hand, naturally desired a continuance of the low rate on cattle, as it perpetuated competition between eastern and western buyers. The controversy between the stock raisers and the packers was thus shifted onto the shoulders of the traffic managers of the railways. The dispute culminated in 1883 when the Trunk Line Association appointed a special committee to consider what the proper adjustment should be.
This committee in turn referred the matter to Commissioner Albert Fink, "Seeking a relativity of rates so as to make the charges for transportation, including the expenses incident to the transportation of dressed beef, the same per pound as the charges per pound of dressed beef transported to the East in the shape of live stock." A difficult task this, considering the variety of by-products emerging into value year by year. Cattle rates had been for some time fifty-two per cent., and then later sixty per cent. of the dressed beef rates. This was relatively higher for cattle than had been charged during the seventies. But the western packers demanded that the relativity in favor of the finished product be still further advanced until cattle rates should equal seventy-five per cent. of the rates on beef. This would effectually discourage the shipment of cattle to eastern centres, and would tend to upbuild Kansas City and Chicago at their expense. In 1884, the matter being still in dispute, was referred to Hon. T. M. Cooley, afterward chairman of the Interstate Commerce Commission. He decided that a fair compromise would be forty cents on cattle from Chicago to New York with coincident rates of seventy cents on beef. This would make the cattle rate about fifty-seven per cent. of the beef rate. It was a victory for the stockmen as against the western packers, who at once raised a great outcry.
It would have been difficult to predict the final outcome had not an entirely new factor appeared, which transformed the conduct of the beef packing industry.[113] Specially constructed stock cars owned by private companies began to be built. These favored the perpetuation of competition between eastern and western packers. To checkmate this, the western packers had already embarked in 1879 upon the ownership of privately owned refrigerator cars for the carriage of their finished products. The custom was adopted by the railways of paying for the use of these cars by making an allowance of so much a mile as a deduction from the established tariffs. This at once opened the way to secret rebates of all sorts. The refrigerator traffic in these private cars was large in volume, very regular and highly concentrated as to source. A large tonnage could be diverted at any time to that road which could best show its appreciation of the favor. The Grand Trunk, for instance, in 1887 swept the board, monopolizing this entire business for a brief time, obtaining it by secret and discriminating rates. The railways, jointly, sought to free themselves from the domination of the large packers; but the phenomenal growth of their business, both domestic and export, rendered them too powerful to resist. According to expert data, during nine months to May 1, 1889, three shippers alone received from one line of road $72,945 for the use of their cars. This about equalled the initial cost of eighty new cars. For the fiscal year 1895, $8,744,000 was paid by the railways of the United States for the use of these cars--about $4,000,000 of this being in the form of rental. At this rate, profits of from twenty-five to fifty per cent. upon the investment accrued to the great packers. These virtual rebates, of course, drove all competitors from the field. The story of the gradual extension of this system of private cars to include fruit and produce business belongs in another place. Suffice it to say that the bondage was broken only by the passage of the Hepburn Act of 1906. The growth of these private refrigerator car lines caused the disappearance of live stock shipments. Packing and slaughtering on a large scale at the seaboard, either for domestic consumption or export, was doomed. Meantime, however, the controversy over the relative rates on beef and cattle continued just as if anything really depended upon it. The issue was again submitted to the commissioner of the Trunk Line Association in 1887. In the following year a select committee of the United States Senate was appointed at the urgent request of the cattle raisers. Testimony before this committee showed in detail how eastern packers were striving to build up establishments near the points of consumption, but were driven out of the business by the relatively high costs of shipping cattle, as compared with the rates at which dressed beef could be actually delivered from Chicago and Missouri river points. This entire history, aside from its significance as a study of personal discrimination, illustrates the effect of a relatively increasing differential rate, partly open and partly secret, against the raw material of an industry as compared with the finished product. The result, at all events, has been to concentrate the packing industry in the Middle West. Nor is the controversy closed even yet.[114] But this time it is a question, not between the seaboard and Chicago, but between Chicago and Missouri river points, or those still nearer the southwestern ranges. Fort Worth and Oklahoma City now become complainants against the Missouri river points.[115] Always and everywhere the manufacture seeks to develop at or near the source of the raw material. Whenever this tendency does not appear in an industry it is pertinent to inquire how far the relative adjustment of rates is responsible for the phenomenon.
Complexities in rate adjustment often arise from the fact that in the manufacture of many commodities the marketing of by-products is of increasing importance. The rate on the whole series of related commodities must be taken into account at once. Thus in lumbering, a large amount of waste or very low-grade lumber is necessarily produced. This common lumber cannot bear long transportation; it must be utilized locally, if at all. On the other hand, the choicest specialties will command a price even in remote markets. A monopoly price is enjoyed in such a case. The Pacific coast lumbermen can market their long timbers anywhere in the United States; but the demand for the common lumber, restricted to a sparsely populated region, tends to be exceeded by the supply.[116] The real competition between the southern, the Michigan, the Wisconsin and the Pacific coast manufacturers thus narrows down to the sale of the medium-grade product. And the cost of production of this is, of course, in part dependent upon the profit made upon the other two sorts, each of which in its own field appears to be a monopoly. A wide market and a good price for medium-grade lumber may so lessen the cost of the cheapest by-products that they in turn may be so reduced in price as to widen their reach to the consumer. Each rate reacts upon the others. The situation can be successfully controlled only by adjusting them all at once.
Not only are rates competitive as between raw materials and the finished product made from them, but the circle of competition immediately widens to include all commodities capable of substitution one for another.[117] Coal rates, of course, are partly determined by rates on cordwood, and vice versa. During the great coal strike in Pennsylvania in 1903, soft coal rates and hard coal rates were sadly disturbed. Such substitutions are always likely to occur. But the conditions are not always so simple as this. An instance in point is given by a witness before the Senate (Elkins) Committee on Interstate Commerce in 1905.[118] This shows how a reduction in the rate for transportation of corn from Kansas to Texas brought about a corresponding reduction in the rate on flour from Minneapolis to Chicago. There was a large crop of corn in Kansas; and the Chicago lines anticipated brisk business in the carriage of this product. The traffic managers of lines from Kansas to Texas, however, discovered a large demand for corn in Texas at a price higher than then prevailed in Kansas. Any rate less than the difference in prices between the two districts would cause shipments of corn to flow from Kansas to Texas, just as inevitably as water flows down hill. This rate would needs be low; but the corn could be loaded on empty southbound cars which had been used to haul cotton out of Texas to the north. This, of course, entailed a diversion of corn from the Chicago railways, which promptly reduced rates in order to hold their traffic. For years the rates upon wheat and corn had been fixed in a definite relation to one another, based upon commercial experience. Any reduction of the corn rate compelled a reduction of the wheat rate. A fall in the wheat rate brought about a drop in the rate on flour. These reductions in corn started in southern Kansas; but parallel lines in northern Kansas were compelled to follow suit. Grain in the territory between the two roads could be hauled by wagon either north or south corresponding to a fraction of a cent per bushel difference in the price. Thus the reduction in rates spread from one line to another all over Kansas, throughout Nebraska up into Dakota and finally to Minnesota. It not only affected the corn rate everywhere but it caused a reduction in the rate on flour from Minneapolis to Chicago. The reliance of Texas for a portion of its corn supply upon the surplus product of Kansas sometimes leads to odd results. This commodity is sometimes shipped as corn meal and sometimes transported as corn to be afterwards ground in Texas. The Texas millers at one time demanded a relative reduction of the rate on grain as compared with corn meal, and the railway commission of that state upheld them in that demand. For ten years down to 1905 the differential in favor of the raw product had been three cents a hundred pounds. Then the railways, in connection with a general advance of rates, increased the charge on corn meal until it amounted to about nine cents per hundred pounds more than the rate on corn. One cent a hundred pounds being a good profit in grinding corn meal, this change shut the Kansas millers out of Texas business. Application was made to the Interstate Commerce Commission for relief. It then appeared on investigation that the carriers had made use of the Texas millers in order to prevent a general reduction of both grain rates and rates on grain products. The Texas millers on general principles had favored both these reductions. What happened is best described in the evidence before the Senate Committee on Interstate Commerce of 1905. "The railways went to the millers of Texas and they said to them, 'Is there anything you want here?' 'Why,' said the [Texan] millers, 'yes; we would like to have that differential between corn and corn meal increased; we think you ought to put the rate on corn meal up.' The railway said, 'All right; you just stay away from that meeting down at Austin so that there will not be any excuse for the Texas commission, and if it undertakes to reduce these rates we will raise this differential; we will raise the rate on corn meal to the rate on flour.' The millers kept away from Austin--they kept their part of the bargain--and they stayed away, and the Texas commission was left without any support for their proposition to reduce the corn rates, and the railway kept their part of the bargain and lifted up the rate on corn meal so that the differential was from nine to seven and one-half cents, and that put the Kansas mills out of business."
Apparently insignificant details often determine the outcome of commercial competition. Thus in the milling business, where the margin of profit in the manufacture of flour may not be over three cents per barrel, an infinitesimal change in the freight rate may mean success or failure to long-established industries. And the conditions vary indefinitely. Thus, as between flour milling in Duluth and Buffalo, Duluth can buy its wheat from the farmer direct during the entire winter, but must ship its product mainly during the period of open water navigation on the lakes. The reverse is true with the Buffalo miller who can ship out his flour during the entire season, but who must accumulate his whole stock of wheat before navigation closes. And then Minneapolis as a milling centre has to be taken into account. Eighty per cent. of the spring wheat grown in the United States is in territory from which the freight rates to Minneapolis and Duluth are the same. But the basic rate to the East and Europe, fixing the all-rail rates, is the combined lake and rail. By this route Duluth is one hundred and fifty miles nearer the market than is Minneapolis, and consequently enjoys a lower rate on its flour shipped out. A three-cornered competitive problem exists, in which any change at one point entirely upsets the commercial equilibrium.
The obligation on the part of a railway to protect its constituency, not only in respect of particular rates, but in general conditions as well, introduces still further complications. The freight business of New England, for example, consists, first, of the carriage of raw materials and supplies inwards; and, secondly, thereafter of the transportation of the finished product out to the consuming markets. Narrowly considered, it may seem expedient to crowd the rate on coal as high as the value of service probably will permit; but viewed in a large way, it may prove to be a far better business policy to maintain the rate on coal, cotton, and other staple supplies so low, that the growth of population and production may in the long run yield far greater returns on the high-grade manufactures which the territory produces. Turning to the southern field, where the economic conditions are reversed, it may be the better policy to hold down the rate on raw cotton in order thereby to stimulate this great basic industry and thereby enhance the demand for the merchandise and foodstuffs which depend upon general prosperity. A free hand afforded for the suitable adjustment of such apparently independent services may contribute far more to the general welfare than an insistence upon a petty and near-sighted policy of extorting from each individual service all the rate it can possibly endure. American railway managers are gradually but surely coming to take a more liberal view of these great possibilities and to consider the economic development of their territories, not narrowly, but in a generous way.
FOOTNOTES:
[64] Testimony before the Hepburn Committee, in 1879, p. 2921, is interesting on this point.
[65] U. S. Reports on Internal Commerce, 1876, p. 25.
[66] U. S. Industrial Commission, 1900, IX, p. 631. Cf. also diagram of European tariffs in Senate (Elkins) Committee, 1905, V, App. p. 271.
[67] P. 165, infra.
[68] Cf. chap. VII, infra.
[69] Such a tariff on the Illinois Central is charted in Reports, U. S. Industrial Commission, IX, p. 295.
[70] Such are commodity as distinct from class rates, described in connection with classification in chap. IX.
[71] Tapering rates are discussed by J. M. Clark in Columbia University Studies in History, etc., XXXVII, 1910, chaps. IX and X. Cf. also Hammond, Railway Rate Theories, etc., 1911, p. 70.
[72] From A. B. Stickney, Railroad Problems, p. 69.
[73] Cf. note on p. 375.
[74] P. 380, infra.
[75] Chapter X, p. 360, infra.
[76] The voluminous record in U. S. v. Union Pacific, etc. (The Merger case), U. S. Supreme Court, October term, 1911, No. 820 abounds in concrete illustrations of all three. Cf. esp. Appellant's Brief of Facts, p. 34.
[77] Senate (Elkins) Committee, 1905, Digest, App. II, p. 10.
[78] Cincinnati Freight Bureau case, 1910, p. 447.
[79] Chapter VIII, infra. Cf. also p. 255. Which line has the advantage?
[80] Albert Fink's detailed description of the numberless alternative routes by which traffic moved into the South, is perhaps one of the best instances in print. U. S. Reports Internal Commerce, 1876, App. pp. 1-16. The Danville, Va., case is an admirable instance. 8 Int. Com. Rep., 409; reprinted in Railway Problems, chap. XVI.
[81] A notable instance between the Southern and Union Pacific roads since their combination. Described fully in our Railway Problems, rev. ed., chap. XXII.
[82] Albert Fink's description in U. S. Reports Internal Commerce, 1876, App. p. 38, is a classic.
[83] Cf. p. 621, infra. Also the dialogue in 21 I.C.C. Rep., 356-359; and Ibid., 414.
[84] 5 I.C.C. Rep., 299; or 22 Idem, 407. Reprinted in Railway Problems.
[85] 14 I.C.C. Rep., 476.
[86] P. 178, infra.
[87] 5 I.C.C. Rep., 264; reprinted in our Railway Problems.
[88] Discussed on p. 232, infra.
[89] Chapter IX.
[90] Details in chap. VI.
[91] Cf. Carload Minimum in chap. IX and the Texas system on p. 393, infra.
The following cases best illustrate these principles: Burnham, Hanna, Munger, etc., 14 I.C.C., 299; and 20 Idem, 141; later in 218 U. S. Rep., 88. (P. 442, infra.) Greater Des Moines Committee, 14 Idem, 294. Indianapolis, Kansas City and Fort Dodge, 16 Idem, 57, 195, and 572. Warnock, 21 Idem, 546 and 23 Idem, 195. St. Louis Business Men's League, 9 Idem, 318. And the Wichita cases in chap. VII, p. 232, infra.
[92] Pp. 248, 392, and 588. Both cases are reprinted in our Railway Problems.
[93] Pp. 125, 241, 398. Also in Railway Problems.
[94] I.C.C. Rep., No. 861; decided Aug. 23, 1906.
[95] Chapters VII and XI.
[96] Read testimony on p. 278, infra.
[97] P. 325, infra.
[98] Described in chap. X.
[99] Procedure is described at p. 282, infra.
[100] Admirably described in Annals Amer. Acad. Pol. Science, April 11, 1908; reprinted in our Railway Problems, rev. ed., Chap. XX.
[101] Similarly in the South, p. 246; and also Texas rates on p. 393.
[102] 5 I.C.C. Rep., 264; reprinted in Railway Problems, chap. VIII.
[103] Theoretical explanation of the flat rate is offered in Chapters I and X.
[104] Best described in McPherson, Railroad Freight Rates, 1909, pp. 67-70. The bitter opposition by New England senators in 1910 to amendment of the long and short haul clause is thus explained.
[105] 7 I.C.C. Rep., 92.
[106] P. 610, infra.
[107] 23 I.C.C. Rep., 151 and 657. Also ibid., 404.
[108] Vide chapter on Localization of Industry in the Twelfth Census of Manufactures, I, pp. 190-214.
[109] Int. Com. Rep., 214; reprinted in Railway Problems. A typical later one is 15 I.C.C. Rep., 351 and Opin. 817, 1909, p. 363. Also Ann. Rep., I.C.C., 1901 and 1902. Hammond, Railway Rate Theories, etc., 1911, p. 21; also, p. 160.
[110] Cf. p. 31, supra.
[111] I.C.C. Rep., No. 917; decided June 24, 1907. Later ones are in 10 Idem, 35 and 16 Idem, 73.
[112] Older cases in Hammond Railway Rate Theories, etc., 1911, p. 45; such as 10 I.C.C. Rep., 428, etc. Later are 11 Idem, 296; 21 Idem, 491; 22 Idem, 77 and 160; and 23 Idem, 656.
[113] The best accounts are in connection with the history of private car abuses. Cf. references on p. 192, infra.
[114] U. S. Supreme Court decision in the Chicago Live Stock Exchange case in 1908; 209 U. S. 108.
[115] 22 I.C.C. Rep., 160; 22 Idem, 656.
[116] 14 I.C.C. Rep., 1-74.
[117] Cf. Hammond, Railway Rate Theories, etc., 1911, pp. 14-17, mainly with reference to classification, however.
[118] Testimony, vol. II, p. 1676. 11 I.C.C. Rep., pp. 212 and 220.
V. RATE MAKING IN PRACTICE (Continued)
Effect of changing conditions, 147.--Lumber and paper rates, 148.-- Equalizing industrial conditions, 148.--Protecting shippers, 149.-- Pacific Coast lumber rates, 150.--Elasticity and quick adaptation, 152.--Rigidity and delicacy of adjustment, 153.--Transcontinental rate system, 154.--Excessive elasticity of rates, 155.--More stability desirable, 159.--Natural v. artificial territory and rates, 159.-- Economic waste, 159.--Inelastic conditions, 161.--Effect upon concentration of population, 162.--Competition in transportation and trade contrasted, 163.--No abandonment of field, 165.
Cost v. value of service, 166.--Relative merits of each, 167.-- Charging what the traffic will bear, 169.--Unduly high and low rates, 171.--Dynamic force in value of service, 177.--Cost of service in classification, 179.--Wisconsin paper case, 181.--Cost and value of service equally important, checking one another, 184.
Not only must rates of all sorts be delicately adjusted to suit the immediate exigencies of trade; they must be constantly modified in order to keep pace with its ever changing conditions. This is peculiarly true of a rapidly growing country like the United States. An admirable instance is afforded by the complaint of the Lincoln Commercial Club before the Interstate Commerce Commission.[119] Lincoln, Nebraska, lies about fifty-five miles southwest of Omaha. Originally all its supplies came from the East, as both cities were for a time outposts of civilization. The coal supply came from Iowa and Illinois, and the salt from Michigan. On these and most other commodities the rates to Lincoln were made up of a through rate from the East to the Missouri river, plus the local rate on to destination. The city of Lincoln thus paid considerably more than Omaha for all of its supplies. Gradually conditions have changed; until in 1907 it appeared that over half the soft coal consumed in Lincoln was brought from Kansas and Missouri; four-fifths of the lumber from the South and nearly all the rest from the Pacific coast; glass and salt from the gas belt and salt beds of Kansas; and a great deal of beet sugar from the western fields. For a large proportion of these and other supplies, Lincoln was actually as near or nearer the point of production than Omaha, and yet the difficulties of effecting an adjustment between rival carriers had prevented any modification of rates corresponding to these changes in economic conditions. On every one of these commodities the rate to Lincoln remained steadily higher than to Omaha, regardless of the source of supply. Unanimous consent was necessary for readjustment. So long as any single road refused assent, a general rate disturbance might be precipitated by any independent action. The beneficent effect of the exercise of governmental authority, powerful enough over all interested parties to compel acquiescence, has been clearly apparent in affording relief.
A similar instance in the state of Wisconsin is afforded by the compulsory readjustment of the freight rate on wood pulp, lumber and sawed logs.[120] On investigation it appeared that, despite a very much lower commercial value for the raw material used in paper manufacture, the rates on pulp wood were more than double those on logs to be sawed up for lumber. It appeared, furthermore, that this apparent anomaly was due not so much to high rates on the pulp wood as to very low rates on sawed logs. These latter rates for many years had been fixed at a very low figure because originally the bulk of such logs, cut in the river bottoms, was floated down stream to mills along the Mississippi river. Competition with lumber raft rates originally determined the charges on lumber by rail. The paper industry did not begin until these conditions of water competition had quite disappeared. Gradually, with the progress of deforestation, all the timber is now found on the uplands far from navigable water courses; so that the rates today are not at all influenced by competitive rates on the lumber rafts down river. Nevertheless the old tariffs on lumber remained in force despite the changed conditions, while the new rates on pulp wood were fixed independently of any rates by water. It was only after careful investigation that the injustice to the paper manufacturers from the disparity in charges appeared. Here again it was the rigidity and interlocked complexity of adjustment which placed it in the power of one road to block change of any sort.[121] The compulsory exercise of governmental authority cut the Gordian knot with the result that substantial justice now obtains.[122]
From the preceding statements it will be observed that carriers have another important commercial function beside that of equalizing industrial conditions.[123] They also act in a protective or insurance capacity to the merchant or manufacturer. The policy of "keeping everyone in business" implies not only variety but variability of conditions. Capital is proverbially timid. It will not venture into a new and uncertain enterprise unless either profits are immediate and high or, if moderate, likely to endure. In any event some guarantee of permanence is required. This guarantee the carrier is often able to offer. It may assume the obligation of protecting its clients; that is, of saving them harmless against the intrusion or irruption of hurtful competition. It thus exercises in a certain sense the function of an insurance company, but with this important difference: that while it has the strongest interest in protecting its established industries against ruinous competition from abroad, it may desire to share in some degree in their development and prosperity by way of reward. In this latter sense the relation of the carrier to its clients partakes of a profit-sharing arrangement. One of the broadest issues between American railways and the public at the present time is precisely this: whether the carriers are to share in business profits; or merely, in addition to furnishing transportation, are to collect a fixed fee for a service in the nature of industrial insurance. That it lies in their way to furnish such protection under modern economic practice is an indisputable fact.
This nice question is almost daily pressing for solution at the hands of the Interstate Commerce Commission. It arises every time an increase of freight rates occurs. Take, for example, the Pacific coast lumber cases of 1908. The dissenting opinions of the Commission show how debatable the proposition is.[124] Up to about 1893 the lumber interests of the Pacific coast were quite undeveloped and entirely dependent upon water transportation for reaching markets. At this time low rates of forty to sixty cents per hundred pounds on forest products to markets in the Middle West were introduced, partly to build up the industry and partly to create a back loading for the preponderantly westbound tonnage of all transcontinental lines. Under these rates the business has enormously developed until, on the Northern Pacific road in 1906, the shipments of lumber east bound amounted to one-third of its entire traffic both ways, and yielded nearly one-fifth of its freight revenue. So greatly had this traffic expanded that it aided, if not actually produced, a reversal of the direction of transcontinental empties. Practically all these roads now have an excess of tonnage to the east whereas ten years ago much the larger volume of freight was moving westward. Meantime the lumbermen under the stimulus of these lower rates, and of the phenomenal rise in the price of lumber, had been wonderfully prosperous. The price of logs had risen since 1893 from about $2.50 per 1,000 feet to $13.50 in 1906; partly in consequence of the extraordinary demand consequent on the Valparaiso and San Francisco earthquakes. The mills had moved in from the rivers and the coast, and had become absolutely dependent upon rail transportation for reaching markets. At this stage, and most unfortunately in November, 1907, just at a time of industrial panic, the carriers raised their rates by about ten cents per one hundred pounds. The market price of logs had already dropped from $13.50 per thousand by approximately one-third. These two causes, commercial depression and the increased freight rate, brought about a complete collapse in the industry. And the increased freight rates were contested before the Interstate Commerce Commission in the hope that, as in the southern field the rate increases from Georgia points had been annulled,[125] these might also be found unreasonable. The broad question concerns the obligation of carriers, once having brought about an investment of capital in the industry, to continue to give the same rates as those under which the ventures had been undertaken, due regard being had, of course, to such changes in costs of service as might have ensued. The lumbermen demand that all the increment of profit due to prosperous developments shall remain unto them; in other words, that the carriers' share of the increased values shall remain fixed. On the other hand, the railways defend their increases, partly upon the ground of increasing expenses of operation, and partly upon the broader ground that the freight rate being proportioned to the price of the product, should rise in harmony with it. Upon this question the Commission was divided, the majority holding in favor of annulling the increase, while the chairman and one other member decided that the increase was justifiable.[126]
Elasticity and quick adaptation to the exigencies of business are peculiarities of American railway operation. Our railway managers have always been most progressive in seeking, in and out of season, to develop new territory and build up traffic. The strongest contrast between Europe and the United States lies in this fact. European railways more often take business as they find it. Our railways make it. Much of this business is made possible only by special rates adapted to the case in hand. These need not be secret or discriminating, as has already been observed. For although offered with reference to particular cases, they may be open to all comers. The economic justification lies in the fact that the railway can afford to make a low rate, leaving a bare margin of profit above the extra cost of adding this traffic to that which is already in motion. Such rates cannot exceed a definite figure based upon what the traffic will bear. A higher rate than this would kill the business. Something is contributed toward fixed charges by the new traffic, so far as the railway is concerned; and at the same time the shipper on his part is enabled to enlarge his operations. Yet such a scale of rates if applied to the whole traffic of the railway might be ruinous in the extreme. The domestic shipper of wheat may conceivably be helped, rather than injured, by a special rate on grain for Liverpool without which the railway would lose the business entirely. To transport California fruit for a mere fraction of the rate per ton mile which is laid upon other traffic may actually enable those other goods to be carried more cheaply than before. Of course, if the other traffic be directly competitive, as for instance in this case, oranges from Florida, that is an entirely different matter. Railway representatives rightfully insist upon these special rates to develop new business as a boon to the commercial world. They contrast them with the hard and fast schedules of European railways. They allege that such elasticity loosens the joints of competition, "keeps everyone in business," equalizes prices over large areas, and is in fact the life of trade. One of the stock objections to railway regulation is that it may lessen this elasticity, "substitute mile posts for brains," and produce stagnation in place of activity.
Paradoxical as it may seem, a certain rigidity of rate schedules is a natural consequence of the very delicacy with which individual rates are adjusted to meet the demands of trade. Each road is jealously and aggressively alert to protect its own constituency regardless of the rights of others. No single traffic manager is free to grant reductions of rates, even when considered to be just, by reason of the opposition of competing lines. The consent of every one of these interests is necessary in order to insure stability, and the penalty for acting independently may be a rate war, disastrously affecting relations with connecting lines. Thus, for example, in the South the Southern Railway for some time was willing to concede, as a measure of justice, a reduction of rates on cotton from Mississippi river points to the mills in North and South Carolina.[127] The growth of the textile industry had resulted in a demand for cotton far exceeding the production of the Carolinas. At the same time the increasing attention devoted to manufacturing of a higher grade had forced the manufacturers to draw upon the long-staple supplies of the Mississippi bottom lands. The Piedmont cotton was too short in fibre for the finer sort of goods. The Carolina mills were, however, compelled to pay a higher rate upon cotton from such points as Memphis than was paid for the long haul up to New England. Thus, for instance, as late as 1900, rates were fifty-nine cents to South Carolina, while they were only fifty-five and one-half cents per hundred pounds from the same points to New England mills. This was obviously unjust. But the Southern Railway alone, interested in the welfare of its Carolina clients, was powerless to act without the consent of its competitors operating from Memphis west of the Alleghanies. These latter lines, having no interest in the southern mills and a unity of interest in the long haul traversed to New England, sought to prevent an equalization of the differences. Controlling rates also on cotton for export to various seaports, they were for a long time able to prevent a change. On the other hand, in the same territory the railways operating south from Cincinnati and Louisville desired to reduce rates on manufactured products from the Central West.[128] These were the very lines which in the former instance prevented the reduction of cotton rates on the Southern Railway to Carolina points, by threats to meet such reductions by cutting their own rates on cotton going north through the Ohio gateways. Yet a reduction of their rates on manufactures for building up western trade threatened the business of the Southern Railway, which had been mainly interested in the traffic from Atlanta seaboard points. It may readily be seen that this situation, extending to practically every important point, "jacked up" all these rates, not because of their inherent reasonableness and not even because the railways independently acknowledged them to be just, but simply and solely because any disturbance of this house of cards might lead to a general downfall of the whole system.
Another interesting example of the difficulty of bringing about a change in rate adjustment is afforded in the transcontinental field. For some years a general agreement seems to have been adopted as a sort of a compromise between the various conflicting interests. Under present conditions Chicago and all points east of the Mississippi from Maine to Florida enjoy precisely the same rate to the Pacific coast.[129] Chicago has at various times contended before the Interstate Commerce Commission for graded rates which should recognize, for instance, that being 1,200 miles nearer San Francisco than Boston on the basis of distance, it should have proportionately lower freight rates. Apparently some of the transcontinental roads, such as the Great Northern, have been willing to make this concession. They could not, however, take any action without first obtaining the consent of every railway and steamship company with which they compete. Inasmuch as almost every railway in the country participates in transcontinental business, an agreement was practically impossible. Entirely aside from the merits of this particular intricate question, it must be borne in mind that there is no such thing as independence of action on behalf of any single carrier. It becomes exceedingly easy for one road to play a dog-in-the-manger part. The shipper may be subjected to an extortionate policy, not dictated by the road over which he ships, as a matter of fact, but by roads operating perhaps a thousand or more miles away.
Praiseworthy as is the elasticity of railway rates in the United States, there is, nevertheless, much to be said in support of the contention that at times this has been carried to an extreme. Stability and certainty have been treated as of secondary importance. Particular shippers have been aided, but the general interests of trade have suffered some injurious consequences. It is not entirely clear whether the advantage gained from elasticity has at all times been worth the cost. Certain of the disadvantages of instability of rates seem to have been overlooked.
In the first place railway tariffs have in the past undoubtedly been too voluminous and complex. The number of these filed with the Interstate Commerce Commission is extremely large. Eleven railways alone during the year to November 30, 1904, filed 30,125. The total schedules of all American railways filed during the year to November 30, 1907, was 220,982. One single carrier had 15,700 tariffs in force at the same time. The New York Central & Hudson River in December, 1899, had no less than 1,370 special commodity rates in force. There were endless contradictions and conflicts. Secret rates were hidden in devious ways in this mass of publications. Special tariffs "expiring with this shipment"; rates quoted not numerically but by numbered reference to tariffs of other carriers and applicable by different routes; agreements to meet rates of any competing carriers, were among the irregular methods of concealment adopted. Although literally complying with the law by publicly filing all tariffs, conditions were often such that not even an expert in rates could discover in this maze of conflicting evidence what the rate at any time actually was. The door was opened wide to personal discrimination and abuses of all kinds.[130] Those conditions are not necessary. They do not obtain on the best roads in other parts of the world. Nor is such instability found in respect of some important lines of trade. No agricultural product fluctuates in price more abruptly or widely than raw cotton,--from five to seventeen cents a pound. Yet the rates on that commodity have remained quite undisturbed throughout the southern states for many years. But the best proof of all that rates have been unduly numerous, is the great reduction in volume which has taken place since 1910 under compulsion of law. This feature will be especially considered in another connection.[131]
The second disadvantage of too great elasticity in freight rates is that it may, at times, promote rather than lessen that state of economic unrest inevitable in all business, especially in a new country. Under a continual disturbance of rates, the merchant is unable with security to enter into long-time contracts. Rates are sometimes changed, not to suit the shipper but to serve the railway's interests. Sometimes traffic may be diverted from its natural channels. The spirit of initiative and self-reliance on the part of shippers may be undermined. Persistent titillation of competition may be pleasant for a time, but its final results may be injurious. Constant appeal to the traffic manager of his road for aid and comfort may quite naturally divert the shipper's attention from an aggressive commercial policy which would render him independent of minor changes in freight rates. The more responsibility the traffic manager assumes, the more may be put upon him. And it must always be remembered that each move by one road to protect a client, will probably be checkmated by the tactics of rival lines. Economic peace, not warfare, should be encouraged by the services of common carriers. One of the positive advantages of governmental regulation of railway rates is that it contributes to stability. That this view is shared by experienced railway men, appears from the following testimony of President Mellen of the New Haven road.[132] "I think that great trouble comes to the business of this country through the fact of these little breaks in rates. During November two new railways were opened into the city of Denver. They sought to make themselves popular by lowering rates, and rates went down very low. They went down legally, but they went down very low. Just before the rates went down the merchants of the city had stocked Denver with goods and the lowering of the rates demoralized their prices; they lost a large amount of money, and dissatisfaction was caused from Chicago to Denver. Lowering of rates demoralized business generally. I think if those roads had known that the rates which they made had to remain in force thirty days they would have hesitated before they lowered them. I would increase the time required before rates could be reduced."
The foregoing consideration suggests still another argument in favor of stability of freight rates, even at the expense of a certain amount of flexibility. Special rates which create new business should be carefully distinguished from special rates which merely wrest business from other carriers or markets. Any expedient which will make two blades of grass grow where one grew before; which puts American wheat into Liverpool in competition with India and Argentina; which cheapens California fruit on the eastern markets; which offers a wider choice of building stone for Chicago; which will establish new industries for the utilization of local raw materials, deserves the greatest encouragement. Our country has been unprecedentedly developed in consequence of the energy and progressiveness of its railway managers. But thousands of other special rates have no such justification, even where they are public and open to all shippers alike. These are the expression of railway ambition to build up trade by invading territory naturally tributary to other railways or traders. A significant feature of commercial competition is the utilization of distant markets as available "dumping grounds" for the surplus products left over from the local or natural market. In the St. Louis Business Men's League case[133] the Pacific coast jobbers complained that the large distributing houses in the Middle West thus invaded their territory. Having met their fixed charges from their own natural territory, they invaded the remotest districts by cutting prices to the level of actual production cost per unit of new business. The Florida orange growers protest against the relatively lower rate on California fruit, which is carried twice the distance for less money per box. This, it is urged, enables the western grower, having glutted his natural market in the Middle West, to "dump" his surplus into the eastern field, to which alone the Florida orange is restricted. This line of argument is the same as that which upholds the systems under which lower rates are given for exported or imported commodities than those on goods for domestic consumption. It is always alleged that such sales at long reach actually benefit the consumer or producer near at hand, inasmuch as they contribute something toward the fixed expenses of the business, which must be borne in any event. This raises at once the much broader question as to what constitutes a "natural market" or the "natural territory" which rightfully belongs to any given economic agent. It is, however, too extended an issue to be discussed at this time.[134]
Too many special commodity rates, intended to meet the needs of particular shippers instead of increasing new business, may merely bring about economic waste through exchange between widely separated markets or by causing an invasion of fields naturally tributary to other centres.[135] Whenever a community producing a surplus of a given commodity supplies itself, nevertheless, with that same commodity from a distant market, economic loss results. Numerous instances could be cited where identical products are redistributed after a long carriage to and from a distant point in the very area of original production. Dried fruits may be distributed by wholesale grocers at Chicago in the great fruit-raising regions of the West and South. Cotton goods made by southern mills may be shipped to New York or Chicago, and then sent back again for final distribution with the addition of a middleman's commission and a double freight rate. The Colorado Fuel & Iron Company seeks special rates in order to sell goods over in Pittsburg territory; while its great competitor, the United States Steel Corporation, has an equal ambition for the trade of the Pacific Slope. In another case it appeared that a sash and blind manufacturer in Detroit was seeking to extend his market in New England. Manufacturers of the same goods in Vermont were simultaneously marketing their product in Michigan. The Detroit producer did not complain of this invasion of his home territory, but objected to the freight rate from Boston to Detroit, which, probably because of back loading, was only about one-half the rate on his own goods from Detroit to the seaboard. Is not this an economic anomaly? Two producers, presumably of equal efficiency, are each invading the territory naturally tributary to the other and are enabled to do so by reason of the railway policy of "keeping everyone in business." The New England railways are compelled by reason of the remoteness to their territory to defend this policy. As President Tuttle, of the Boston & Maine, expresses it, "I should be just as much interested in the stimulating of Chicago manufacturers in sending their products into New England to sell as I would be in sending those from New England into Chicago to sell. It is the business of the railways centering in Chicago to send the products from Chicago in every direction. It is our particular business in New England to send New England products all over the country. The more they scatter the better it is for the railways. The railway does not discriminate against shipments because they are east bound or west bound. We are glad to see the same things come from Chicago into New England that are manufactured and sent from New England into Chicago." No one questions for a moment that the widening of the sphere of competition by transportation agencies is a service of incalculable benefit to the country. But it should also be borne in mind that superfluous transportation is economic waste. The industrial combinations in seeking to effect a strategic location of their factories in order to divide the field have apparently come to a full recognition of this fact.
A fourth objection to undue development of special commodity rates is that they may entail increased burdens upon the local constituency of each railway. The proportion of such special rates is fifty per cent greater in America than in the United Kingdom. It is plain that each shipment which fails to bear its due proportion of fixed charges, even though contributing something thereto, leaves the weight of interest and maintenance charges upon the shoulders of the local shipper. To be sure, those special rates which permanently create new business, operate otherwise. But in the vast complex, each railway often wrests from competing carriers only about as much tonnage as it loses. It invades rival territory, but its own constituency is invaded in retaliation. Thus there is rolled up an inordinately large proportion of such special traffic, leaving the regular shipments and the local trade to bear the brunt of fixed charges. Momentous social consequences may result. Not only the cost of doing business, but the expense of living in the smaller places is increased. One of the most dangerous social tendencies at the present time is the enormous concentration of population and wealth in great cities. Increased efficiency and economy in production are much to be desired; but social and political stability must not be sacrificed thereto. Is it not possible that a powerful decentralizing influence may be exerted by checking this indiscriminate and often wasteful long-distance competition, through greater insistence upon the rights of geographical location?
Finally, an abnormal disregard of distance, which is always possible in the making of special rates to meet particular cases, may bring about a certain inelasticity of industrial conditions. This may occur in either one of two ways. The rise of new industries may be hindered; or the well-merited relative decline of old ones under a process of natural selection may be postponed or averted. The difficult problem of fairly adjusting rates on raw materials to finished products in order that the growth of new industries may take place, while at the same time the old established ones shall not be cramped or restricted, has already been discussed. It is equally plain that at times there may be danger of perpetuating an industry in a district, regardless of the physical disabilities under which it is conducted. One cannot for a moment doubt the advantages of a protective policy on the part of railways; safe-guarding industry against violent dislocating shocks. An inevitable transition to new and perhaps better conditions may perhaps be rendered easier to bear. To New England, constantly exposed to the competition of new industries rising in the West, this policy has been of inestimable value. On the other hand, it is incontestable that in the long run the whole country will fare best when each industry is prosecuted in the most favored location, conditions of marketing as well as of mere production being always considered. If Pittsburg is the natural centre for iron and steel production, it may not be an unmixed advantage to the country at large, however great its value to New England, to have the carriers perpetuate the barbed wire manufacturers at Worcester. If California can raise a finer or more marketable variety of orange, and at a lower cost, than Florida, it would be a backward step to counteract the natural advantage of the western field by compelling the southern railways to reduce their rates to an amount equal to the disability under which the Florida grower works. The principle laid down by the so-called "Bogue differentials" in the lumber trade[136] bears upon this point. In order to equalize conditions between a large number of lumbering centres sending their products to a common market, certain differentials between them were allowed under arbitration, "to enable each line to place its fair proportion of lumber in the territory." Did this mean that the disability of any place in manufacturing cost, should be compensated by a corresponding reduction in the ensuing transportation cost? This was the view of some of the carriers who were zealous to keep the market open to all on equal terms. Yet it is evident that, carried beyond a certain point, such a policy would not only nullify all advantages of geographical location, but it would also reverse the process of natural selection and of survival of the fittest, upon which all industrial progress must ultimately depend. Each particular case, however, must be decided on its merits. Our purpose is not to pass judgment on any one, but merely to call attention to the possible effect of such practices upon the process of industrial development.
Centralization, or concentration of population, industry and wealth is characteristic of all progressive peoples at the present time. Great economic advantages, through division of labor and cheapened production, have resulted; but, on the other hand, manifold evils have followed in its train. Sometimes it appears as if American railway practices, in granting commodity and flat long-distance rates so freely, operated in some ways to retard this tendency. But the influence is not all in that direction. Many staple industries, utilizing the raw material at their doors, might supply the needs of their several local constituencies, were it not that their rise is prevented by long-distance rates from remote but larger centres of production. Denver, in striving to establish paper mills to utilize its own Colorado wood pulp, is threatened by the low rates from Wisconsin centres. Each locality, ambitious to become self-supporting, is hindered by the persistency of competition from far away cities. This is particularly true of distributive business. The overweening ambition of the great cities to monopolize the jobbing trade, regardless of distance, has already been discussed. And it follows, of course, that the larger the city the more forcibly may it press its demands upon the carriers for low rates to the most remote hamlets. The files of the Interstate Commerce Commission are stocked with examples of this kind. The plea of the smaller cities and the agricultural states--Iowa, for example--for a right to share in the jobbing naturally tributary to them by reason of their location, formed no inconsiderable element in the recent popular demand for legislation by the Federal government.
The marked difference between competition in transportation and trade has long been recognized in economic writing, but has not as yet been accorded due weight in law. The most essential difference arises from the fact, already fully set forth, that a large proportion of railway expenditures are entirely independent of the amount of business done. This involves as a consequence, the exemption of carriers from the fundamental law of evolution. Survival of the fittest does not obtain as a rule in railway competition. The poorest equipped, the most circuitous and most nearly insolvent road is often able to dictate terms to the standard and most direct trunk lines. This has been exemplified time and again in the history of rate wars the world over.[137] The bankrupt road having repudiated its fixed charges has nothing to lose by carrying business at any figure which will pay the mere cost of haulage. The indirect line having no business at the outset has nothing to lose, and everything to gain. The Canadian Pacific, for example, was perhaps originally built without any expectation of being able to participate in San Francisco business; and yet, like the Grand Trunk, it has always been an active factor in the determination of transcontinental tariffs.
The fact is that cost of production, while in trade fixing a point below which people may refuse to produce or compete, in transportation may merely mark the point at which it becomes more wasteful to stop producing than to go on producing at a loss. Hadley's classic statement is so admirable that it cannot be improved upon. "Let us take an instance from railway business, here made artificially simple for the sake of clearness, but in its complicated forms occurring every day. A railway connects two places not far apart, and carries from one to the other (say) 100,000 tons of freight a month at twenty-five cents a ton. Of the $25,000 thus earned, $10,000 is paid out for the actual expenses of running the trains and loading or unloading the cars; $5000 for repairs and general expenses; the remaining $10,000 pays the interest on the cost of construction. Only the first of these items varies in proportion to the amount of business done; the interest is a fixed charge, and the repairs have to be made with almost equal rapidity, whether the material wears out, rusts out, or washes out. Now suppose a parallel road is built, and in order to secure some of this business offers to take it at twenty cents a ton. The old road must meet the reduction in order not to lose its business, even though the new figure does not leave it a fair profit on its investment; better a moderate profit than none at all. The new road reduces to fifteen cents; so does the old road. A fifteen cent rate will not pay interest unless there are new business conditions developed by it; but it will pay for repairs, which otherwise would be a dead loss. The new road makes a still further reduction to eleven cents. This will do little toward paying repairs, but that little is better than nothing. If you take at eleven cents freight that cost you twenty-five cents to handle, you lose fourteen cents on every ton you carry. If you refuse to take it at that rate, you lose fifteen cents on every ton you do not carry. For your charges for interest and repairs run on, while the other road gets the business."[138]
Another peculiarity of railway competition, distinguishing it from competition in trade, is that there is no such thing as abandonment of the field. This is tersely expressed by Morawetz in his Corporation Law. "It should be observed that competition among railway companies has not the same safeguard as competition in trade. Persons will ordinarily do business only when they see a fair chance of profit, and if press of competition renders a particular trade unprofitable, those engaged in that trade will suspend or reduce their operations, and apply their capital or labor to other uses until a reasonable margin of profit is reached. But the capital invested in the construction of a railway cannot be withdrawn when competition renders the operation of the road unprofitable. A railway is of no use except for railway purposes, and if the operation of the road were stopped, the capital invested in its construction would be wholly lost. Hence it is for the interest of the railway company to operate its road, though the earnings are barely sufficient to pay the operating expenses. The ownership of the road may pass from the shareholders to the bond-holders, and be of no profit to the latter; but the struggle for traffic will continue so long as the means of paying operating expenses can be raised. Unrestricted competition will thus render the competitive traffic wholly unremunerative, and will cause the ultimate bankruptcy of the companies unless the operation of their traffic which is not the subject of competition can be made to bear the entire burden of the interest and fixed charges." So profoundly modified in short are the conditions of railway competition by contrast with those in industry, that it is clear beyond a shadow of doubt that a railway is essentially a monopoly. This requires no proof so far as local business, in distinction from through or competitive traffic, is concerned. It is equally true in respect to all traffic of sufficient importance to bring about pooling agreements or a division of the business, in order to forfend bankruptcy and consolidation. To attempt to perpetuate competition between railways by legislation is thus defeating its own end. The prohibition of pooling agreements which refuses to recognize the naturally monopolistic character of the business, can have but one result, namely, to compel consolidation as a measure of self-preservation. Such legislation defeats itself, bringing about the very result it was intended to prevent.
* * * * *
Two general theories governing the rates chargeable by railways are entertained, known respectively as cost of service and value of service. According to the first, the proper rate for transportation should be based upon the cost for carriage of the persons or goods, with an allowance for a reasonable profit over and above the expenses of operation involved. This line of argument is commonly advanced by representatives of shippers and the public, who reason by analogy from other lines of business. In several European countries when railways were first built, and afterward, especially in Germany in 1867, attempts were made to apply this principle widely in the construction of tariffs. Practical railway men, on the other hand, usually adhere to the second principle of value of service. This argument maintains that, while theoretically cost of service should determine minimum rates, owing to the nature of commercial competition, as a matter of fact rates must be based upon the principle of charging what the traffic will bear. This is accomplished by proportioning the rate to the commercial value of the service. Practically the rate is found by charging as much as the traffic will stand without evidence of discouragement. Thus if the price per bushel of wheat in New York is twenty-five cents higher than in Chicago, it would obviously be absurd to charge a rate which would absorb all of that increment of place value due to transportation. Enough margin must be left to the shipper who buys wheat in Chicago and sells it in New York, to permit a reasonable profit on the transaction, after payment of the freight rate.
These two principles of cost of service and value of service are directly opposed in one regard; inasmuch as the cost of service theory harks directly back to railway expenditure; while the value of service principle contemplates primarily the effect upon the railway's income account. Any charge is justified according to the latter view, which is not detrimental to the shipper as indicated by a positive reduction in the volume of business offered. No charge, on the other hand, may be deemed reasonable according to the cost of service principle, which affords more than a fair profit upon the business, regardless of its effect upon the shipper. As a matter of fact neither of these views is entirely sound by itself. Both have large elements of truth in them. Each qualifies the other. In the first place, it is to be noted that between them they fix the upper and lower limits of all possible charges. Less than the cost of service cannot be charged; else would a confiscatory rate result. This was the plea set up by the railways in the now celebrated Texas Cattle Raisers' Association case against the cancellation by the Interstate Commerce Commission of an extra charge of $1 per car for switching charges at Chicago. At the other extreme, more than the traffic will bear cannot be charged without a disproportionate decline in volume of tonnage. This would be bad business policy, as it could at once entail loss of revenue. The railway could not submit to the former alternative; it would not conceivably resort to the latter.
Attempts have been made by various authors to account for the phenomena of rate making on other grounds. The German author, Sax, has sought to trace an analogy between the imposition of taxes and railway charges, alleging that both should be proportioned to what the shipper "can afford to pay," from an ethical rather than an economic point of view. Acworth interprets the phrase "charging what the traffic will bear" to mean something analogous to this. His allegation is that rate schedules are built up upon the principle of "equality of sacrifice," otherwise characterized as "tempering the wind to the shorn lamb." High class traffic contributes liberally of its abundance of value, while third class passengers and low grade tonnage are let off lightly on the ground of their poverty. Taussig in his memorable contribution to the subject[139] has, however, shown how untenable this theory of "equality of sacrifice" is. Not ethical but purely economic considerations are applicable in such circumstances except, of course, in so far as common carriers, enjoying privileges by grant of the state, may be considered as imposing taxes for the performance of a quasi-public duty. This latter test of a reasonable rate has underlaid a long line of Supreme Court decisions since the Granger case.[140] Nevertheless, as so frequently happens, legal and economic bases of judgment seem to be lacking in harmony.
There can be no question that for an indispensable public service like transportation, conducted under monopolistic conditions, the ideal system of charges would be to ascertain the cost of each service rendered and to allow a reasonable margin of profit over and above this amount. To the application of this principle alone, however, there are several insuperable objections both theoretical and practical. Such cost is practically indeterminate, being joint for all services in large part, as we have seen: it is highly variable, being perhaps never twice the same, as circumstances change from time to time; cost is unknown until volume is ascertained, and volume is ever fluctuating; the cost of service, obviously, could never be ascertained until after the service had been rendered, while, of course, the schedule of rates must be known in advance, in order that the shipper may calculate his probable profits; and finally the principle of increasing returns, flowing from the dependence of cost upon volume of traffic, imposes such an incentive for development of new business, which in turn depends for its volume upon the rate charged, that cost of service is subordinated at once to other considerations in practice.
Of these objections to rate making upon the principle of cost of service alone, it would indeed appear as if the first should be conclusive. If the cost is simply indeterminable, why bother about any further refutation of the principle at all? But the persistency of the idea that somehow railway operations are analogous to the business of an ordinary merchant; and that cost and profits are ascertainable; renders it necessary to pile proof upon proof of the limitations upon its applicability to real conditions in service.
Not only is the mere cost of service indeterminable; if it could be ascertained, it would not establish the chargeable rate in many instances. The freight service of a railway comprises the carriage of all kinds of goods simultaneously, from the most valuable high-priced commodities, such as silks and satins, down to lumber, coal, cement, and even sand.[141] To compel each of these classes of goods to bear its proportionate share of the cost of carriage, would at once preclude the possibility of transporting low-priced goods at all. One dollar a hundred pounds may not be too much to add to the price of boots and shoes for transportation from Boston to Chicago.
It would still form only a small part of the total cost of producing and marketing them. But to add anything like that sum to the cost of one hundred pounds of salt or cement would put an end to the business at once. Only about so much can in practice be added to the price of any given commodity for freight without widely limiting the area of its available market. Thus raw cotton seems to be able to bear an addition of about fifty cents per hundred pounds for freight to its total cost. Experience demonstrates that anything more than this one-half cent per pound charged on cotton, entails more loss than gain. In the case of fancy groceries or fine furniture, there may be no considerable demand in any event above a certain ascertainable level of prices. For boots and shoes or cut building stone it may be that competition from some other centre of production nearby, precludes any great addition to the price for freight. The business simply will not bear more than a certain proportion of charge. Not only would the rigid application of the cost of service principle hinder all transportation of low-grade traffic; it would also prevent any development of long distance business. It is indubitable that sole reliance upon cost of service as a basis for rate making is theoretically unsound, and impossible of practical application.[142]
Cost of service, while unsound as a sole reliance, nevertheless affords an important check upon the value of service principle. Without it there is always grave danger that traffic managers, seeking to enlarge their revenues, may push rates unreasonably high. At first sight it would appear as if this could not occur, inasmuch as an inordinately high rate would immediately reduce the volume of business offered. It is constantly alleged by railway men that this must of necessity occur. And it would indeed follow, were it not that the incidence of the rate is rarely upon the actual shipper. He merely pays it, and at once shifts it to the consumer. For low-grade or staple goods like cement or kerosene, where transportation charges form a large part of the total cost of production, it is conceivable that higher freight rates might so far increase the price as to check consumption. Five cents a hundredweight higher freight means $1.25 per 1,000 ft. added to the price of soft lumber, $2 to hard lumber; three cents per bushel added to the price of wheat, and $1 to the ton of pig iron or coal. Such substantial additions might readily reduce the demand. Yet even this would not be true of necessities of life like anthracite coal or sugar, on which latter the freight rate amounts to about one-half cent per pound. Is five cents a barrel added to the price of flour likely to decrease the consumption of that staple commodity? Yet the enhancement of railway revenues would indeed be enormous from such an increase of freight rates. For these necessities of life, an increased freight rate might become an actual charge upon the people, without reducing their consumption, like a tax upon salt. Only upon goods the use of which might be freely lessened, would higher freight rates be reflected in a corresponding decline in the volume of business. Moreover, with all high grade traffic, the value of service principle fails utterly by itself alone to prescribe the upper level of a reasonable charge. Competent testimony is ample upon this point. Thus from the commissioner of the Trunk Line Association;[143] "The tonnage of the higher class articles is an extremely difficult matter for transportation companies to increase or decrease.... In that class of articles the carrier can do but little to increase the transportation." And the reason in part lies in the almost immediate diffusion of the burden in the processes of distribution. That no complaints are made--a defence often brought forward for higher rates--proves by itself the uncertain incidence of the burden imposed.
That the principle of charging what the traffic will bear affords no protection to the consumer against exorbitant rates on many commodities, follows also from the relative insignificance of transportation charges as compared with the value of the goods. This, in fact, is naively conceded by railway managers themselves; when, as in the case of the widespread freight rate advances of 1908-1909, publicity agents flooded the country with calculations as to the infinitesimal fraction which would be added to the price of commodities by a ten per cent, rise in rates.[144] The rate from Grand Rapids to Chicago on an ordinary dining room set of furniture, being $1.60, a ten per cent. increase would add only sixteen cents to the cost. A harvester transported one hundred miles would be enhanced seventeen and a half cents in price; a kitchen stove carried from Detroit to the Mississippi would only cost twenty-five cents more; and the price of a Michigan refrigerator sold in New York, would be only seven and one-half cents higher; were freight rates to be increased by ten per cent, in each instance. On wearing apparel the proportions were represented as even more striking. An ordinary suit of clothes transported three hundred miles, under similarly enhanced rates, would, it was alleged, cost only one-third of a cent more. For all their apparel, made in New England, consisting of everything from hats to shoes, each wearer in the Middle West would be affected by a ten per cent. rise of rates by less than one cent apiece. True enough all this; and a striking testimonial to the effectiveness of the railway service of the country! But at the same time, if a ten per cent. increase of rates is inappreciable to the consumer, why not increase them by twenty per cent.[145]
And what becomes of the argument that charging rates according to what the traffic will bear, is an ample safeguard against extortion? Many of these small changes in price are diffused in the friction of retail trade;[146] some of them are unfortunately magnified to the consumer, especially under conditions of monopoly. When freight rates on beef go up ten cents per hundredweight, the consumers' price is more likely than not to rise by ten times that amount. But even assuming the final cost to follow the range of transportation charges closely, is it not evident that, so small relatively are many freight charges by comparison with other costs of production, that consumption is not proportionately affected by their movement one way or the other? And yet the entire argument that the value of service principle is a self-governing engine against unreasonable rates, is based upon this assumption. Surely the increased income to the carriers when rates are raised must come from someone. Because it is not felt, is no reason for denying its existence as a tax. But the very fact that it is not felt, undermines the argument that a safeguard against extortion obtains. The theorem that value of service in itself affords a reliable basis for rate making, pre-supposes that freight rates and prices move in unison; a supposition which a moment's consideration shows to be untenable in fact.[147] Such cases must be finally settled by some reference, indefinite though it be, to the cost of conducting that particular service; or rather, as Lorenz puts it, to the extra cost incident to that service. This extra cost may oftentimes be segregated, where the total cost could not be ascertained.[148]
That the problem is, however, a most difficult one is evidenced by the periodic controversies over railway mail pay.[149]
Of course in order that any change of rates should be reflected in prices, all carriers must of necessity agree upon the matter. The price is made by the least expensive source of supply. So that any carrier refusing to raise rates, might aid in the continuance of an already established price. Under conditions of transportation prevalent in the United States twenty years ago, the likelihood of an increased freight rate becoming a tax upon the community, was lessened by the probability that either by means of secret rebates, or by special and perhaps open commodity rates, some roads might choose to protect their clients against enhancement of prices. Markets were local--not reached by great systems operating from remote sources of supply. The policy of the northern transcontinental lines in making lumber rates from Oregon to the Middle West, might be quite independent of any policy in force on the southern hard pine carrying roads. But under present day conditions, the entire area of the United States is one great market. Hence, with rebates eliminated and with practical monopoly established through actual consolidation, control or harmony of policy, the carriers have the consumers much more completely at their mercy. Only two safeguards for the public interest remain. One is government regulation, or at all events supervision, of charges. The other is "enlightened self-interest"--which in transportation matters means a full appreciation of the possibilities and limitations in the application of the value of service principle to the determination of rates.
Considerations of cost of service afford protection, not only against unreasonably high rates, but also against unduly low charges. The evil in such cases is not only that the carriers operate at a loss, but that inequality and discrimination are inevitable concomitants of too low rates. No railway conceivably, of course, will charge unremunerative rates for a long time. But it sometimes happens that managements may be led to the adoption of policies of temporary expediency, not compatible with the long-time welfare of stockholders. During the presidency of Charles Francis Adams on the Northern Pacific in 1890 an unaccountable and unnatural diversion of traffic from this road to the Atchison, Topeka & Santa Fe suddenly occurred.[150] A large volume of freight from the East to Oregon was diverted to the roundabout route via Southern California. On investigation it appeared that the English banking house of Baring Brothers, having become involved in unfortunate Argentine speculation, and being obliged to force a market for its investments in Atchison securities, demanded an immediate showing of large gross earnings regardless of the net profits. Orders to get traffic at any price went forth. A market was made for Atchison stock; although it was powerless to prevent the firm's final bankruptcy. In such a case the only safeguard against unreasonably depressed rates by the Atchison road, which, of course, immediately compelled corresponding reductions by the natural routes to the Northwest, should have been consideration of the actual cost of moving traffic by so long and roundabout a route. And yet this consideration was entirely ignored. Another illustration of the same danger occurred in April, 1903.[151] A gang of western speculators unobtrusively acquired control of the Louisville & Nashville road, by taking advantage of the issue by that company of a large amount of new stock. This they did by the use of borrowed money. They had no intention, even had they been sufficiently well financed to do so, of permanently controlling the road as an investment. They bought the stock merely in order to resell it at a higher figure. They threatened the railway world with a general disturbance of rate conditions throughout the South. Their plan was to cut rates and steal traffic from other roads in order to make a large show of gross earnings; and to unload their stock holdings on the market thus made, before the public learned the truth. This was prevented only by repurchase of their stock at very high prices. In such a case, what guidance would the principle of charging what the traffic would bear, afford? Cost of service must be invoked in order to determine the reasonableness of the low rates in force.
In any industry where rates are made under conditions of monopoly rather than of free competition, it is imperative that cost of service be constantly held in view. Under conditions of free competition it is bound to obtrude itself automatically; but under monopoly it must oftentimes be forcibly invoked. The shipper whose manufacturing plant has once been located in a certain place is no longer free to accept or reject a certain rate. He can afford neither to move nor to abandon his works. In order to continue in business he must meet the prices made by competitors. This price may be made elsewhere under more favored circumstances. To a manufacturer an increase of freight rates instead of curtailing output, may lead to attempts to lessen the costs of production per unit by an enlarged output sold at cut prices. Under such conditions an enhanced freight rate is a positive deduction from profits without any gain to the consumer. It is impossible to trace any safeguard against extortion in the operations of a value of service law under such circumstances. An instance in point is afforded by a complaint of the Detroit Chemical works in 1908.[152] This company imported iron pyrites through Baltimore from Spain; that being the source of the bulk of the material used here in the manufacture of sulphuric acid. The Detroit Company sold its product throughout the West in competition with companies at St. Louis, Chicago and Buffalo. The companies at Chicago and St. Louis enjoyed low import rates by way of the Gulf ports. The Buffalo concern used to be favored by a low rate said to be due to canal competition on shipments from New York. Since 1903, however, the rate on pyrites from Baltimore to Detroit had been steadily increasing, from $1.56 to $2.72 per long ton. Even this latter rate by itself does not seem absolutely excessive, yielding a revenue of less than four mills per ton mile. But here again, it was not the absolute but the relative rate upon which the continued welfare of the industrial concern depended. The question had to be decided, not on the basis of cost, but from the point of view of the value of the service to the user. The carriers after this petition was filed voluntarily reduced the rate fifty-one cents per ton in January, 1908. The relative rate as compared with that to other competitive points was thus more equitably adjusted. The Interstate Commerce Commission on a review of the evidence held that this increase to $2.72 was unreasonable and unjust so long as it had been in effect; and awarded reparation to the amount of fifty-one cents per ton on all shipments made during its continuance.
It is indisputable that the great dynamic force in railway operation inheres in the value of service idea. The traffic manager who is always considering how much it will cost to handle business, will seldom adventure into new territory. The United States, as a rapidly growing country, is consequently the field in which charging what the traffic will bear, has been most ardently upheld as the only practicable basis for rate making. A few detailed illustrations will serve to show the results of its application in practice. Not infrequently does it happen that rates are different over the same line for shipments between two given points in opposite directions. Where this is due to a preponderance of traffic in one direction, and a consequent movement of "empties" which invite a back loading at very low rates, the difference of charges according to direction may actually be due to differences in the cost of carriage.[153] An empty train, which must be returned from New York to Chicago for another loading of grain, or to Georgia or Oregon for shipments of lumber, if loaded with merchandise, can be moved with no allowance for dead weight of cars or locomotives; inasmuch as the train must move in any event, whether loaded or empty. But even where this defence of difference in the cost of service fails, the practice may be entirely proper from every point of view. By increasing the total tonnage a special rate may ultimately contribute to lower charges all along the line. Raisin culture began in California in 1876. Prior to that time the Spanish product had supplied the American market. The first thing to do was to find a market for the California raisins in the East. They would not bear the freight rate which had previously been charged for Spanish raisins moving over the transcontinental lines westward. A very low rate was all that the new traffic would bear. During the year 1876 therefore 70,000 lbs. of California raisins were carried east at one and three-fourths cents per 100 lbs., while simultaneously 1,000,000 lbs. of Spanish raisins were carried west over the same lines at a rate of three cents. No such difference in the cost of service in opposite directions existed, although a preponderance of empties moving eastward undoubtedly cheapened the service from California. The aim of the commodity rate was to upbuild a new industry. How far this succeeded appears from the fact that in 1891, no Spanish raisins were carried west at all; while the eastbound shipments amounted to 37,600,000 lbs.[154] The preceding illustration leads us then to this further conclusion. The cost of service principle might most conceivably be applied to a railway in a purely static state. But, dynamically considered, as involving the growth and development of business, it fails utterly by itself to meet the necessities of the case.
At times it is inevitable that cost of service and value of service considerations come flatly into opposition. Usually, as in the California raisin case or in the grant of low rates on Oregon lumber east bound about 1893, they reinforce one another; that is to say, the lower rate given to build up business obtains on a service given at lower cost. But it sometimes happens that shipments of the same commodities over a line in opposite directions may occur and that the lower rate applies to the (presumably) more costly service. In 1906 a manufacturer in Menasha, Wis., complained to the Interstate Commerce Commission[155] that his rates on woodenware to the Pacific slope were ten cents per 100 lbs. higher than were rates on the same goods between the same points east bound, notwithstanding the fact that the empty car mileage west bound was then three times as great as in the contrary direction. The movement of empties west bound would certainly seem to justify as low if not lower rates on the basis of comparative cost of operation, supposing that there was coincidence in time. Only one satisfactory explanation for this apparent anomaly suggests itself; viz., that this low eastbound rate was given to build up a new industry in the West. In other words, the cost of service, a dependable guide for a road in a static condition, failed of effect upon a line possessed of great dynamic possibilities. Occasionally opposition of principles like this may occur in questions of classification. It may temporarily be worth while, in order to build up a new industry, to accord a lower rating to a commodity actually more valuable or more expensive to handle than others. Here again the dynamic force in the value of service principle out-weighs all other considerations of relative cost of service.
The value of service principle in general fails, not only in the determination of absolutely reasonable rates, but it is inadequate also to the solution of perhaps the more difficult problem of relative rates. This question of relativity is twofold; first as between different places, and secondly as between different commodities. These are, in other words, the problems respectively of distance tariffs and of classification. The manner in which distance tariffs evolve, has already been discussed, and it is evident that the cost of service principle is of fundamental importance, even though it be tempered by considerations of commercial expediency, that is to say, by the necessity of at all times under stress of competition, charging only what the traffic will bear. But while the value of service principle--charging according to demand in other words--applies at the competitive points, the other principle of relative cost should be the fundamental one in fixing upon the scale of local non-competitive rates.
The second phase of the problem of relativity arises in connection with classification.[156] How shall goods be graded in respect of their freight charges for identical services in carriage? Besides illustrating the interplay of the two fundamental principles, this topic serves also to clear up another possible confusion of terms. Proportioning transportation charges to the value of the service must always be clearly distinguished from basing them upon the mere value of the goods. Nothing is more certain than that no direct causal relation between freight rates and the intrinsic value of commodities is traceable. On wire the freight rate between two given points may be about one-fourth of the commercial value; on sheet iron one-third; on lumber somewhat more, and on hay two-fifths; while on cattle and hogs the freight rate may range as low as one-tenth to one-eighth of their commercial value. On coal, on the other hand, the freight rate often more than equals the price of the coal at the mine, and on very low grade commodities like bricks, the transportation charges may equal two or even three times the worth of the goods.[157] For each locality or even direction, these percentages will change. Positive reasons for these varying relationships are discernible in local trade conditions. While in general cheap goods are rated lower; if for any reason--bulkiness or risk--they cost relatively more to transport, they may very properly be advanced in grade. Normally, raw products move at lower rates than finished products--for instance, wheat and flour or cattle and beef. This is in accord with charging what the traffic will bear in relation to value. But in the making of export rates, it may be to the interest of the carrier to reverse this order, actually according to the finished product the lower rate, thereby encouraging the development of manufactures at home rather than abroad.[158] Classification committees and regulative commissions are thus compelled to waver between the two opposing considerations of cost and value. One cannot avoid the conclusion, however, that, contrary to the usual rule, in this field of classification undue weight is often accorded by railway managers to that small element of total cost of service arising from risks of damage in transit--insurance cost, in other words--to the neglect of the financially more important consideration of what the traffic will bear. This emphasis upon the cost side of the account by classification committees, oddly enough is peculiarly characteristic of ratings in the higher class commodities. Among low grade goods, like grain, lumber or coal, the risk of damage is small, so that insurance cost becomes almost negligible. The insistent consideration among these low grade commodities is much more apt to be that of relative demand; arising from the necessity of close and constant adjustment to the behests of trade. Special or commodity rates, based directly upon what the traffic will bear, rather than upon the element of cost, are likely to prevail in these cases. But the very large revenue which could be obtained from increasing the rates upon the higher grade of goods seems not to be fully appreciated.
A valuable instance of the play of opposing considerations of cost and value of service in the classification of freight rates is afforded by the complaint in 1908 of the pulp paper makers in Wisconsin, already cited in another connection.[159] It appeared that for similar service over the same roads, the rates per carload on saw logs for lumber were only about one-half those charged for carriage of logs to be ground into paper pulp. Judged on the basis of commercial value, hemlock and spruce bolts, too short and often otherwise unfit for lumber, were worth much less than saw logs; and yet they paid double the freight rates. This was not because the pulp wood was less desirable as traffic. In many ways it was more so. The haul was twice as long as for saw logs. The paper mills brought relatively more supplementary tonnage in the form of coal, food stuffs and supplies for workmen and their families. Fully as much of the finished product to be reshipped to consumers resulted. While smaller in volume, the pulp wood business was far more permanent. It was growing rapidly while the lumber business was declining. Moreover, the actual cost of service in hauling pulp wood was fully as low as for lumber logs. Carloads were much heavier, and were more regular in movement. In practice they involved no milling-in-transit obligation, that is to say, no obligation to re-ship the finished paper out over the same road; while all the saw log rates carried this obligation--a matter of some moment to the railways. And finally the value of the service to shippers of pulp wood was less than to mere lumbermen; in other words, the paper makers were operating under closer margins of profit; their plants were more costly, and depreciated more rapidly. The defence of the carriers in this case was not that the rates on pulp wood were too high in themselves, but that the rate on saw logs was perhaps unduly low--the latter having been crowded down to a minimum figure by competition in the early days of the business by the lumber raftsmen who floated the saw logs downstream from the forest to the saw mills. But of equal importance probably in perpetuating the higher rates on pulp logs, was the assumption that while the value of the bolts themselves was perhaps even less than that of saw logs, the value of the resultant product, paper, was much greater than that of lumber. But the Wisconsin Railroad Commission, in entire harmony with the principle repeatedly laid down by the Federal commission, held that the carriers must be guided by real distinctions of cost from a transportation standpoint and not by gradations of value. If the goods were bulky, awkward, or risky to handle, perhaps requiring special appliances or equipment, relatively high classification was permissible. But if they were substantially similar for purposes of carriage, no gradation in rates based upon differences in the ultimate uses to which the commodity might be put would be upheld. Such was the reasoning of the Interstate Commerce Commission in a decision, holding that fire, building and paving brick must be accorded equal rates, regardless of their differing values.[160] That the element of value is, however, not negligible is brought out in a later Federal case,[161] wherein it was recommended that cheap china, to be given away as premiums in the tea trade, be rated nearer ordinary crockery or earthenware, even though shipped in the same manner as high grade china ware. Under the official classification, chinaware is rated first class if in boxes, and second class in casks. Earthenware or crockery is carried at twenty per cent, less than third class, in small packages (L. C. L.). On the basis of mere cost of service, it would seem as if boxes of chinaware should have a lower rating than casks. Boxes stow better than casks, with less risk of breakage. But the commercial practice being to ship the finer grades of chinaware in boxes, such shipments are graded higher because the traffic will usually bear a higher rate. Thus considerations of cost of service yield to those of value. The Interstate Commerce Commission, however, noting the exceptional circumstances under which the tea company distributed its cheap chinaware, recommended a revision of the classification to meet the needs of the case; in other words ordering a greater emphasis upon the elements of the value of the service, even at the expense of relative cost of operation.
Our final conclusion, then, must be this: That both principles are of equal importance; and that both must be continually invoked as a check upon each other. The tendency to the elevation of cost of service to a position of priority--rather characteristic of regulative bodies and of legislators--is no less erroneous than the marked disposition of railway managers to insist upon the universal applicability of the principle of charging what the traffic will bear. Neither will stand the test of reasonableness alone. Whether the one or the other should take precedence can only be determined by a careful study of the circumstance and conditions in each case; and in practice, the instances where either principle becomes of binding effect to the entire exclusion of the other, are extremely rare.
FOOTNOTES:
[119] 13 I.C.C. Rep., 319. The general investigation of wool rates is another admirable instance. 23 Idem, 151.
[120] Wisconsin Railroad Commission, 1908. Cf. p. 181, infra.
[121] The diverse interests to be reconciled must also include the lumbering centres once "next the stump," but now placed at a relative disadvantage. The Eau Claire lumber case [reprinted in Railway Problems, pp. 203-233] should be read in this connection.
[122] The remarkable rise of the sash, door and blind industry in the South, as prejudiced by comparison with Chicago under an outworn schedule of rates, is given in 23 I.C.C. Rep., 110.
[123] On the parity cases, consult Hammond, Railway Rate Theories, etc., 1911, pp. 120 and 149.
[124] 14 I.C.C. Rep., 1-74 and Ann. Rep. I.C.C., 1911, p. 46. The later judicial history will be found at p. 543, infra.
[125] P. 489, infra.
[126] Rates must not vary with profits. 13 I.C.C. Rep., 429; and consistently held ever since.
[127] Arbitration of Cotton Rates, etc., Nov. 15 and 16, 1900; pamphlet arguments of Southern v. Illinois Central Railways. Wool rates are the same. 23 I. C. C. Rep., 151.
[128] This was the gist of the complaint in the Cincinnati Freight Bureau case; pp. 248, 392 and 588, infra.
[129] Chapters XI and XIX, infra.
[130] Now covered by law since 1910. Pp. 512 and 571, infra.
[131] Pp. 324 and infra.
[132] Senate Committee on the Transportation Interests of the United States and Canada, 1890, p. 362.
[133] 9 Int. Com. Rep., 318; in our Railway Problems, chap. XVII.
[134] Hammond, Railway Rate Theories, etc., 1911, p. 82, cites cases.
[135] Chapter VIII, infra.
[136] 5 Int. Com. Rep., 264; in our Railway Problems, chap. VIII.
[137] Cf. p. 255 et seq., infra.
[138] A carload of bamboo steamer chairs from San Francisco to New York for $9.40 in the course of a rate war, would seem to be rather below bed-rock. 21 I. C. C. Rep., 349.
[139] Quarterly Journal of Economics, V, 1891, pp. 438-65; reprinted in Railway Problems, chap. V.
[140] Cf. Int. Com. Reports, 1903, p. 436.
[141] The Hepburn Committee testimony in 1879, p. 2893, is eloquent upon this aspect of the question.
[142] 1st Annual Report, I.C.C., 1888. Cf. Strombeck, Freight Classification, pp. 35-60.
[143] C., N. O. & T. P. case, testimony, vol. II, pp. 332-333.
[144] Cf. The Freight Rate Primer, bearing no authors or publishers name, but largely compiled from addresses by President W. C. Brown of the New York Central & Hudson River. Similar arguments and computations occur in the testimony before the Senate (Elkins) Committee of 1905, pp. 1162 and 2276.
[145] Now who will say that it is unreasonable to charge 7-1/2 cts. to carry a suit of clothes from Chicago to New York.... Railways could charge three or four times the cost of transportation for a pair of drawers and the rates would still be reasonable.... But all the first-class rates are of that nature.--Albert Fink, testimony, C., N. O. & T. P. case, p. 290.
[146] Senate (Elkins) Committee, 1905, p. 1162.
[147] In re Proposed Advances in Freight Rates, I.C.C., April 1, 1903.
[148] An interesting illustration of such determination of separable or extra cost was the computation by which the movement expenses of a train load of 50 cars of grain, 80,000 lbs. to the car, from Buffalo to New York were fixed at $520. I. C. C. Reports, 1903, p. 397. Or again in the estimation of the costs of operation in the express service from New Orleans to Kansas City in the banana trade. I. C. C. Rep., No. 1235, 1908. The able Wisconsin Railroad Commission has carefully studied a number of such cases, notable in its Two-Cent Fare decision of 1906.
[149] Cf. Tunell, Railway Mail Service, Chicago, 1901.
[150] Personal correspondence.
[151] Details in vol. II.
[152] 13 I.C.C. Rep., 357.
[153] 5 I.C.C. Rep., 299.
[154] On raisins compared with citrus fruits: 22 I.C.C. Rep., 1.
[155] Interstate Commerce Commission, No. 797.
[156] More in detail in chap. IX.
[157] Senate (Elkins) Committee, 1905, testimony of Mr. Bird, Traffic Manager of the St. Paul road. This is best measured, of course, by revenue per ton mile, chap. XII, infra.
[158] Flour v. wheat, p. 135, supra.
[159] P. 148, supra.
[160] More in detail at p. 318, infra. Also Hammond, Rate Theories of the I. C. C., 1911, p. 32.
[161] U. P. Tea Co.; I.C.C. Rep., No. 1569, 1908.