Transportation rates and their regulation; a study of the transportation costs of commerce with especial reference to American railroads

Front matter

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Cornell University Library HE 1843.B75

Preface

In writing this book, I have aimed to present a complete theory of transportation rates and their regulation, to illustrate this theory with a sufficient number of concrete cases arising in actual regulation to make the reader or student feel that the presentation is thoroughly practical, and, throughout, to keep before the reader a realization of the relation of rate making to trade,' testing each rate structure or regulation by its probable effect in securing or failing to secure the maximum of really profitable commerce and the largest economic well-being of the community. Whether a given level of rates is so high that, like tariff restrictions, it will prevent commerce which ought to take place, or whether it is so low (less than cost) that, like most bounties, it will encourage commerce that ought not to take place, or whether rates are discriminatory in such a way as to affect commerce injuriously, are the questions kept constantly in view. As a protective tariff may prevent profitable trade, so may monopolistic transportation rates. As the protective poUcy may, perhaps, benefit persons in one section of a country at the expense of those in another section, so discriminating transportation rates may arbitrarily build up one city and ruin another. As tariff protection may divert a country's industry out of its most profitable channels, so may discriminating railroad rates arbitrarily encourage one industry in a given territory or section and discourage another. As tariff barriers may further the development of private monopoly, so may discrimination in vi PREFACE

rates among competing shippers. Arguments are presented tending to show the uneconomy of the " basing-point " system and of discrimination favoring intrastate as against interstate traffic. Yet, on the other hand, certain apparent discriminations among places, among different kinds of goods, and between different directions, are seen, upon analysis, to be not quite analogous to protective tariffs and bounties but to be economically defensible.

That the inner philosophy of rate regulation and of the general disapproval of various rate practices once common, should be understood, some such presentation of the principles of rate making and of rate regulation as is here offered, would seem to be essential. It ought to be given at least as much importance and to be emphasized in college classes at least as much, as the mere record of past legislation and description of existing law. Indeed, if, as we are so often told, the principal function of our colleges is to prepare the younger generation for citizenship, then the things they need to learn there, perhaps most of all, are the reasons of public policy which sometimes do, and which always should, lie back of and condition our legislation.

A number of chapters of this book will appear also as Part III of my Principles of Commerce, shortly to issue from the press. A few footnote references to " Part I " and " Part II " are to that other work. The present "Book is confined to the discussion of transportation problems and is, as to these, more complete than the other.

I am under obligation to The American Economic Review for permission to republish, as Chapter II, in practically its original form, an article on The Competition of Transportation Companies, first published in

PREFACE vii

December, 1914. To Professors Irving Fisher and Clive Day of Yale College and to the late Professor G. S. Callender of the Sheffield Scientific School, Yale University, I owe critical reading of selected chapters. To Professor John Bauer of Cornell University I am under obligation for a careful and valuable criticism of practically the entire book. To my wife I am under dbligation for aid in gathering data, for criticism throughout, and for reading the proof.

HARRY GUNNISON BROWN.

Columbia, Mo.,

February, 1916.

Chapter I Fagb

§ 1. Preliminary Remarks on the Expenses of Railroads. § 2. Classification of the Expenses of Rail Transportation. § 3. Influence which these Various Expenses Have and Should Have on the Determination of Railroad Rates. § 4. Average Railroad Rates as Affected by Degree of Utilization of Railroad Capital. § 5. Expenses and Rates of Water Transportation. § 6. Comparative Importance of General Expenses and Fixed Charges, on Railroads, on Natural Waterways, and on Canals. § 7. The Proper Basis of Wharf Charges. § 8. Economic Objections to Monopolistic Transportation Rates. § 9. Summary.

CHAPTER II The Competition of Transportation Companies . . 37 § 1. Competition of Routes. § 2. Circumstances which May Make Carriage of Goods by a Longer Route More Economical than their Carriage by a Shorter Route. § 3. Competition of Directions. § 4. Competition of Locations. § 5. Competition against Potential Local Self-sufficiency. § 6. Two senses of " What the Traffic Will Bear." § 7. Summary.

Chapter III

§ 1. Monopoly of Rail Transportation. § 2. Agreements between Navigation Companies. § 3. Other Causes of Monopoly in Water Transportation. § 4. The Function of Government in Relation to Transportation Monopoly. § 5. Summary.

X TABLE OF CONTENTS

Chapter IV Pags

Economically Undesirable Rate Discrimination among

Places 94

§ 1. Competition as a Cause of Discrimination among Places. § 2. Economic Loss which May Flow from Discrimination among Places. § 3. The Uneconomy of Discrimination either in Favor of or against Imports. § 4. The Uneconomy of the " Basing Point " System. § 5. Discrimination in Favor of Intrastate Business, resulting from Orders of State Commissions. § 6. Discrimination by a Transportation Company in Favor of Traffic Moving a Long Distance over its Own Lines. § 7. Summary.

CHAPTER V Economically Defensible Discrimination among Places . 120 § 1. Discrimination among Places, by a Roundabout Line. § 2. Discrimination by the Longer or Longest Line, when there is Competition of Directions or of Locations. §3. Discrimination by the Shorter or Shortest Line, when Such a Line has Comparatively Light Traffic. § 4. Discrimination among Places, by a Railroad Competing with a Water Line. § 5. Discrimination among Places, by a Railroad Competing with Local Self-sufficiency. § 5. Discrimination in Favor of Export Traffic. § 7. Discrimination between Directions. § 8. Summary.

CHAPTER VI Relative Rates on Different Goods 160

§ 1. Why Rates on Competing Goods should be in Proportion to Transportation Cost. § 2. The Proper Relation of Rates on Finished Products to Rates on Raw Materials. § 3. When Rates may Properly be Lower on Some Kinds of Goods than on Others, in Relation to Cost of Carriage. § 4. Summary.

Chapter VII

§ 1. Methods of Practicing and of Concealing Discrimination among Shippers. § 2. Competition of Transportation Lines as Causing this Discrimination. § 3. Other Causes

TABLE OF CONTENTS xi

FAGB of Discrimination among Shippers. § 4. The Practice of Discriminating among Shippers, Tested by the Principles of Industrial and Commercial Ethics. § 5. Summary.

CHAPTER VIII Steps in the Development of Rate Regulation in the

United States 193

§ 1. Extent of the Rate-regulating Power. § 2. Rate Regulation by the State Governments. § 3. The Interstate Commerce Act of 1887. § 4. The Amendment of 1906. § 5. The Amendment of 1910. § 6. Later Legislation. § 7. Summary.

CHAPTER IX Rulings of the Interstate Commerce Commission

Reasonable Rates 219

§ 1. Difficulty of the Interstate Commerce Commission's Rate-regulating Problem. § 2. Reasonable Rates as Evidenced by Comparison. § 3. Reasonable Rates as Tested by Cost of Service. § 4. Earnings as a Test of Reasonableness. § 5. Reasonable Rates in Relation to the Fair Value of Railroad Property. § 6. Efficiency of Management in Relation to Reasonable Rates. § 7. Summary.

Chapter X

Rulings of the Interstate Commerce Commission : Discrimination among Places . - 244

§ 1. Undue Preference in Relation to Distance. § 2. Undue Preference in Relation to Natural Advantages of Location. § 3. Undue Preference to Traffic Moving Entirely or Largely over the Discriminating Railroad. § 4. The Long and Short Haul Clause and Comparative Size of Cities. § 5. The Long and Short Haul Clause, and Discrimination by the Longer or Longest Line. § 6. The Long and Short Haul Clause and " Market " Competition. § 7. The Long and Short Haul Clause in its Proper Application to a Direct Line with Light Traffic Competing with a More Roundabout Line Having Dense Traffic. § 8. The Long and Short Haul Clause and Water Competition. § 9. Import and Export Rates. § 10. Summary.

xii TABLE OF CONTENTS

Chapter XI Page

Rulings of the Interstate Commerce Commission : Discrimination AMONG Different Goods and among Shippers 281

§ 1. Relative Rates on Competing Goods. § 2. Relative Rates on Raw Material and Finished Product § 3. The Bearing of Water Competition on the Relation of Rates Charged for Carrying Different Kinds of Goods. § 4. Value of Commodity in its Relation to Rates. § 5. " Devices " for Discrimination among Shippers. § 6. Summary.

Chapter XII

Uneconomical Government Interference with, and Encouragement of, Transportation 299

§ 1. Navigation Laws. § 2. Subsidies to Native Shipping. § 3. Government Operation of Merchant Ships. § 4. Indirect Subsidies, Favoring Native Ships as Compared with Foreign Ships. § 5. The Free Use for Navigation, of Government-built Canals. § 6. The Improvement of Harbors. § 7. The Improvement of Rivers. § 8. Subsidies to Railroad Building. § 9. Summary.

TRANSPORTATION RATES AND THEIR REGULATION

TRANSPORTATION RATES AND THEIR REGULATION

CHAPTER I The Cost of Transportation §1

Preliminary Remarks on the Expenses of Railroads

Before taking up a consideration of transportation rates, or of economical versus uneconomical carriage of goods,^ we may, with advantage, analyze transportation costs. We shall begin by classifying and discussing the expenses of railroad companies.^ Scarcely any of the expenses which a railroad company has to meet can be said to vary in exact proportion with the traflSc. Even the cost of fuel and the wages of engineers and trainmen do not vary in exact proportion with amount of goods carried, or in exact proportion with the number of cars or the number of trains hauled. But it is probably not widely false to state that such expenses as these will vary, in any given period, about as the number of trains

> Except as such carriage of goods has already been considered in Part II, Chapter VIII.

' The writer has found particularly helpful, though he has not followed it throughout, the analysis of ton mile cost in Woodlock's A natomy of a Railroad Report and Ton Mile Cost, New York (S. A. Nelson), 1900, Chapters I to V, inclusive, of Ton Mile Cost. See pp. 86 and 87 of Woodlock for summary of classification.

times the average number of miles a train is taken during that period. If we bear in mind that, within the limits permitted by reasonable frequency of trains, the number of cars to a train will be, on the whole, the best paying (i.e. the length of train will be the best paying), then we may say that these expenses (for fuel, wages of engineers, etc.) vary, in a considerable degree, as traffic varies. Other railroad expenses, however, seem to have much less relation and, in some cases, almost no relation to the quantity of transportation business done.

By a parallel argument it may be shown that no appreciable amount of a railroad's expenses can be exactly allocated to (regarded as particularly caused by) any special traffic. For example, suppose coal and live stock to be carried in the same train load. Much of the expense of carrying is a joint expense, e.g. the cost of fuel and the wages of engineer and fireman. If the coal and the Uve stock are carried in the same train, it will appear difficult, if not impossible, to determine how much of the cost of running the train is a cost of carr)Tng coal, and how much is a cost of carrying live stock. Yet when train loads are homogeneous, made up, each, entirely of one kind of goods, some expenses may be allocated, such as fuel cost, engineer's wages, etc. It can be determined, approximately, what is the cost per train load of hauling coal, and what is the train load cost of hauling live stock. From this we may deduce the cost per ton mile of hauling each. But there are other and more general railroad expenses which cannot thus easily be allocated, or attributed to different kinds of traffic, any more than they can be said to vary in proportion to traffic. What is needed is a careful analysis of the expenses of a railroad, with a view to determining the relation which these expenses have to amount and kinds of traffic, and the influence which they have and ought to have on rates.

§2 Classification of the Expenses of Rail Transportation

In attempting such an analysis, we may divide the expenses of a railroad into four classes, in rough proportion to the relative exactness with which these expenses vary as traffic varies, and in proportion, also, as they are easily and clearly attributable to different kinds or to different lots of traffic. The first class of expenses of a railroad company includes all expenditures for the production of train mileage, train mileage being defined as the total number of trains run during a given period, times the average number of miles a train is run. The expenses in this first class will be found to be the most variable and apportionable of any. Second, there are terminal expenses, which are variable in proportion to volume of traffic and are in some degree apportionable, but which have no relation to the distance goods are carried. Third, there are the general expenses, or preparatory and complementary expenses, which are slightly variable within wide Umits, but which are not Ukely to vary much, if at all, with small changes in the volume of business, and which cannot, to any considerable extent, be allocated, or attributed to any special traffic. The fourth class is made up of the so-called fixed charges (or the sunk costs), which, once the road has been built, are not at all variable as traffic changes, or at all attributable to different parts of the total business done.^ Let us consider these four classes of railroad expenses in the above order.

Expenses for the production of train mileage include some half dozen different subclasses of expense. First, there is the cost of production of locomotive power. This cost includes wages of engineers and firemen, value of coal burned, of oil and tallow used, etc. Second, there are expenses for maintenance of equipment, such as repairs of engines and cars. The third item among expenses for production of train mileage is a part of the cost incident to maintenance of way. Renewals of rails and renewals of switches and of rail fastenings, so far as they are due to wear and hence depend upon the nimaber of train miles, are maintenance of way expenses which must be classed as being for the production of train mileage. The same thing is to be said, in part, of expenses for tie renewals. In part, these renewals are necessitated by weather conditions and are not related to the use made of the tracks, but in part they depend upon this use. This third item includes also such repairs of roadbed as are not due to weather and floods, and includes, further, a certain amount of bridge repairs. Fourth, the expenses for the production of train mileage include the cost of train service and supplies. This means particularly the wages of trainmen, oiling, and, in the case of passenger trains, heating and lighting. Fifth, there is the cost of superintendence and supervision in the movement of trains, a cost which depends in large part upon the number of trains to be run and the average distance they are to be run. Other expenses might perhaps be mentioned, which pertain particularly

• See, however, later paragraphs of this section (2), in which the possible requirement of additional construction is discussed.

to the production of train mileage, but those here given are fairly inclusive, and will at least serve for illustration.

The expenses above given incident to the production of train mileage are the operating expenses which vary in some approximate proportion with the trains moved times the average number of miles, i.e. with train mileage. They do not, however, vary in exact proportion to the number of trains times the average number of miles that trains are run, since trains are not aU of the same length or loaded with equally heavy cargoes. The cost of running long and heavily loaded trains is greater for the same distance than the cost of running less heavily loaded and shorter trains. Yet it is not greater in proportion to the larger amount of goods carried, until the train load of maximimi efficiency has been reached.^ This train load will be, where circumstances favor, the largest which the most efficient and economical type of engine for the purpose can conveniently draw. The cost in fuel and labor of drawing such a train load, obviously will not be twice as great as the cost of drawing the same train loaded to but half its capacity or of drawing a train of half the length. The expense of production of train mileage does not, therefore, increase as rapidly as business increases, except in the case of a road (or part of a road) whose volume of business is already so great as to permit the train load of maximum economy. Where traffic is not heavy, the frequency of service required for public convenience makes impossible the larger trains and heavier loading which otherwise

' The special case of traffic taken to fill cars which must otherwise be returned empty to their starting point is discussed in Chapter V (of Part would be attempted. The first class of expenses, therefore, that for the production of train mileage, increases as the amount of traffic increases, but does not increase, on the average road, as rapidly as traffic increases.

The second class is terminal expenses. These, too, may properly be regarded as operating expenses. They are the expenses for loading and unloading freight, when this is done by the railroad company transporting it and not by the consignor and consignee. They include, also, expenses of switching, expenses for making up trains, expenses incident to repairing terminals, so far as this repairing is occasioned by the use of these terminals, and, in general, expenses incident to collection and handling of freight and passengers at terminals proper and at intermediate points. The amount of freight and the number of passengers carried affect these expenses, though probably not proportionally, but the distances the freight and passengers are carried do not afifect them.

General, or preparatory and complementary, expenses constitute the third great class of costs. These general expenses we may subdivide, in the main, into two subclasses. First, there are a part of the expenses for general direction and supervision, for clerical work, for soliciting traffic, etc., which would not need to be incurred if a railroad company should elect to do no business at all, but which, nevertheless, vary comparatively little even with marked increases and decreases of traffic, and which, with, perhaps, the partial exception of soliciting expenses, can be allocated hardly at all, i.e. cannot be said to be especially incurred for this or that part of the traffic. Such expenses are among those sometimes described as joint costs ^ of all the traffic. Second, there are many expenditures for maintenance of plant, such

• As by Taussig in the Quarterly Journal of Economics, i8gi, Vol. V, pp. 438^-465. Pigou, in his Wealth and Welfare, London (Macmillan & Co.), 1912, pp. 21S-219, criticizes the view that railway transportation is essentially a business of joint costs. See, also, discussion between Professors Taussig and Pigou in the Quarterly Journal of Economics for February, May, and August, of 1913. While the method of approaching the theory of rates, in this book, may appear to be essentially that of the joint cost theorists, the conclusions reached have been carefully qualified in the text and in footnotes, and it is hoped that any substantial basis for criticism on that score has been avoided. It must be admitted that the carrying of (say) two commodities, e.g. wheat and coal, by railroad, is not a case of joint cost in quite the same sense as the production of, for example, beef and hides. The transportation of the wheat and coal is a case of joint cost (if we wish to use that expression), only in the sense that certain expenses do not vary proportionately whether traffic (within wide limits) is large or small, only, that is, in the sense that the plant which is constructed primarily, perhaps, to carry the wheat, cannot be fully utilized in transporting the wheat and may also be used, without correspondingly greater expense, to carry the coal. But, supposing the size of railroad plant of maximum economy to have been reached, a larger and larger demand for the transportation of wheat would not increase — it would, rather, decrease — the possible supply of the service of transporting coal.

So long as the plant was but partially utilized in transporting the wheat, it might be possible to carry the coal at very low rates, because the relatively constant expenses were chiefly covered by the charge made for transporting the wheat. But when the plant came to be more fully utilized, with, perhaps, a possibility of being completely utilized, in transporting the wheat, the transportation of coal would be a compeUlive rather than a complementary use of the plant ; and even before the capacity of the plant was put to the test by traffic all of which was able to pay its proportionate share towards the general expenses and fixed charges, the increased demand for the transportation of wheat might somewhat raise the rates on the transportation of coal. The production of beef and hides is a typical case of joint cost. An increased demand for beef tends to raise its price and to encourage its production. Such increased production of beef necessarily involves the first stage of, and a partial meeting of the expenses of, an increased production of hides, and so tends to lower the price of hides. (See Fisher, Elementary Principles of Economics, New York — Macmillan — , 1912, p. 349.) Somewhat analogously, the transportation of wheat, when this requires the prelimmary construction of a railroad plant which cannot be completely utilized by carrying wheat only, may involve the first stage of, and a partial meeting of the expenses of, the transportation of coal, and so may tend to make possible the transportation of coal at very low rates. But a further increase in the transportation of wheat would decrease rather than increase the facilities which might be available for the transportation of coal and would be likely to raise the rates for such transportation.

as renewals of ties, repairs of roadbed, etc., which are not dependent upon the amount of train mileage, which have, perhaps, very little relation to the amount or kind of traffic, but which are necessitated by weather conditions or other extraneous circumstances, and which must be met to a degree, if a railroad company intends to do any business at all.' Not only are these expenses of the third class not dependent upon amount of traffic, but they cannot be allocated to different kinds of traffic.

Fixed charges constitute the fourth main class of costs.^ This class includes interest on a company's

> A very great decrease of traffic might, of course, make possible a decrease in the administration expenses and an abandonment of part of the plant, e.g. one of several tracks, with resultant saving of maintenance costs. On the other hand, an increase of business sufficient to require additions to the plant, e.g. additional trackage, would involve added expense for maintenance and, perhaps, supervision. But, within wide limits, general expenses are largely independent of the volume of business.

• The Interstate Commerce Commission has, as one of its duties, to prescribe a system of accounting for all interstate railroads. In carrying out this duty, it has made a classification of expenses considerably different from that above described. (See Statistics of Railways in the United States, 1910, pp. 85, 86.) Operating expense accounts of the railroads are made to include items for :

I. Maintenance of way and structures (such as for upkeep of roadbed and bridges) ; this was $425,173,389 in the year ending June 30, 1913, for all the railroads of the United States. (For this and for the following figures, see Statistics of Railways in the United States, 1913, pp. 50, 51, and 52.)

n. Maintenance of equipment (upkeep of engines, cars, etc.); this was $513,406,662 in 1913.

m. Traffic expenses (as those for advertising and for soliciting traffic) ; in 1913 this was $63,082,500.

IV. Transportation expenses (such as wages of engineers, trainmen, and yardmen and cost of fuel), totaling $1,101,742,932 in 1913.

V. General Expenses (including administration, insurance, etc.), amounting for all the roads, in 1913, to $79,363,517.

In addition to these operating expenses, there are such fixed charges as rentals (totaling $133,903,011 in 1913) and interest on funded debt ($380,145,142), besides a few minor deductions from revenue.

This classification, however, though it may be much more practical for many purposes of accounting and supervision than the one which we have followed, is not equally significant in the study of railway rate making. For such operating expenses as those pertaining to maintenance of way and structures and to main-

THE COST OF TRANSPORTATION ii

debt, rentals which it may have obligated itself to pay for the privilege of operating certain branch lines or using certain tracks, and taxes. These expenses are the least variable among all the four classes. In fact, once a sufficient trackage and other facilities have been constructed, most of them do not vary at all with changes of traffic. Whether traffic be large or inconsiderable, profitable or the reverse, interest on the debt must equally be paid when due. Likewise it is obvious that these fixed charges cannot be allocated to any special part of the traffic of a road, cannot be said to be incurred for the sake of any particular traffic.

But it may be objected that a railroad need not have much of fixed charges, that it may have leased no branch lines and may have no debt, that its capital may have been raised entirely by the sale of stock and not at aU by the sale of bonds. In that case, the annual fixed charges would have relatively small or no importance. Fixed charges, however, are in large part but interest on the original cost of a railroad system. Interest paid to bondholders is interest on cost ; rentals are, in effect, interest on cost (or estimated value) of branch and other leased roads. If, then, there are no fixed charges, there are at least sunk costs. These sunk costs represent the

tenance of equipment, as well as the so-called "trafiSc expenses, " are in considerable degree independent of amoimt of business. In order to estimate the character of their influence on rates, we may with advantage group a part of each of these classes, for example, those for mamtenance of way so far as dependent on weather conditions, with general expenses. Other maintenance of way expenses, dependent largely on amount of business, may profitably be grouped with "most of the "transportation expenses" under the general title of expenses for the production of train mileage. Still other expenses, drawn from one or more of the Interstate Commerce Commission's categories, may, with gain to our study, be classed as terminal expenses. Thus we are naturally led back to the division of railroad expenses into those for the production of train mileage, terminal expenses, general expenses, and fixed charges.

amounts already invested in terminals, way, construction, and equipment, including, therefore, both necessary land or space, and the improvements, structures, and equipment, which are the products of labor. So far as the investment in a railroad represents borrowed capital, the aimual interest may be regarded as a measure of the investment made, and is entirely independent of trafl&c. If none of the capital was borrowed and no interest has to be paid, we may say that the original cost of building the road has been sunk once for all and cannot be recovered, however small the trafl&c, and that it cannot be attributed to any particular part of the traflB.c. The amount sunk is equivalent to, and would have been exchangeable for, the perpetual annual interest on that amount, and vice versa. In either case, this expense, once the investment is made, is independent of traflic.^

Let it be said, in this connection, that the fixed charges, or the sunk costs of a great railroad system, are usually sums of great magnitude. A railroad system is a highly capitalistic enterprise even in a capitalistic era. In some kinds of business, yearly running expenses are a large part of the total expenses, and the initial cost is low. But railroading is a business of the opposite type. However large are the yearly expenses of a road, i.e. the expenses of doing, the expense of becoming overshadows these. The predominant fact in a railroad company's history is building the road, and the existence and rela-

' If existing facilities are insuffident for the possible traflSc, and further construction is necessary, then, it may be said, the cost of such construction, or the annual interest charge on it, is occasioned by the additional traffic sought, and may be attributed to this additional traffic which requires it. Yet here again, once the additional track laying or other construction has been done, the sunk costs, or the fixed charges on the investment, are the same whether the additional traffic sought proves to be heavy or light.

tive magnitude of this primary cost has large significance in the problem of rate making.

It is commonly stated that the railroad business is subject to a law of decreasing cost, or, as it is sometimes expressed, of increasing returns. Taking the expenses as a whole, they do not increase in proportion to business. But it should be emphasized that the tendency to decreasing proportionate cost with increasing traflSc applies, in its full extent, only up to the point where the railroad plant is most economically utilized. Up to that point, increasing traflSc will not correspondingly increase expenses.* After that point is reached, greater business may require the expense of new construction and of maintenance of a larger plant than before. Until this larger plant is utilized nearly as fully as was the smaller one, total expense per unit of business is likely