Throttling the Railroads: 4. The Nature of Railroading

Dr. Carson is a frequent contributor to THE FREEMAN and other journals and the author of several books, his latest being The War on the Poor (Arlington House, 1969). He is Ex­ecutive Director of the Constructive Founda­tion in Atlanta, Georgia.

There were two basic charges against the railroads which pro­moted the increasing government regulation and control over the years. One was that they discrimi­nated among their customers, par­ticularly among shippers, and that this discrimination resulted in un­just rates. Specifically, critics claimed that the railroads favored those making large shipments over those making small ones, that they charged more for some short hauls than they did for long ones, that they gave preferential rates to some cities and denied them to others, that they gave rebates to strategically situated shippers, and that they gave free passes to in­fluential persons to ride passenger trains. These practices were said to be unjust because they meant that small shippers, those living in cities or towns without prefer­ential rates, farmers, and people without influence were not only paying their own way but were also subsidizing favored custom­ers.

The second charge against the railroads was that competition among them was imperfect. Some locations were served by several railroads and might have, in addi­tion, water transport available, while others would be served by only one railroad. Those who were served by competing lines bene­fited from lower rates, while those with only one line between points were charged what the traf­fic would bear. Of course, this was only the simplest level of the charge about competition. Re­formers have actually been quite ambivalent toward it; if it does not exist, they picture the cus­tomer at the mercy of a single company; if it does exist, they are apt to describe with horror the competitive practices. The legis­lation fostered over the years re­flects the ambivalence of the re­formers toward competition. At any rate, they charged that com­peting railroads formed pools to divide up the freight or passen­gers or receipts, as the case might be, thus reducing or eliminating the benefits from competition. Or, they charged that the railroads cut each other’s throat when they competed. The effect of the latter was supposed to be that they charged very low rates for com­petitive traffic and made up their losses by much higher rates for noncompetitive traffic. Pooling, of course, raised the monopoly buga­boo—that monopoly conditions would prevail generally and that everyone would have to pay what the traffic would bear.

In sum, a picture was drawn that made government regulation of rates and control over service appear necessary if justice were to prevail.

The Facts Were Irrelevant

Theoretically, the charges might be dismissed as irrelevant and im­material. The railroads were the private property of their owners in almost all cases; as such, the owners should be free to discrim­inate against whom they would and charge whatever rates suited them and provide such services as pleased them. For good or ill, how­ever, it is this position that is irrelevant. It is historically ir­relevant because the railroads have been and are regulated and con­trolled. It is irrelevant in America because we have a variety of pop­ular government and, if enough of the people can be persuaded that injustice exists, measures will be taken to correct it. In any case, such has happened. Thus, the question of the justice of railroad practices must be tackled head on. This will lead us to an examina­tion of the economics of railroad­ing which will, in turn, clarify the issues which prompted regula­tion and show why the regulation, when it came, produced the re­sults that it did.

Let it be stipulated, at the out­set, that the railroads did some­times engage in the practices which their critics described. That is, they sometimes charged more for a short haul than a long haul, gave rebates, gave preferential rates to large shippers, favored some shipping points over others, formed pools, gave out free passes, and so forth. Whether such prac­tices worked injustices upon the customers of the railroads is an­other matter.

Justice?

To be just means, so far as I can make out, to give to each man his due. In economic terms, it means that a man should have what he has earned or what has been given him by someone who earned it. So long as the railroads provided the service for which they were paid and at the rate agreed upon with each party to a contract, there would appear to be no further question of justice at issue. That is, the practices charged against the railroads could be dismissed simply as in­volving no instance of violation of contract. If they had, anyone unjustly treated by violation of contract would have recourse to the courts. No new laws were needed to provide such justice.

What the reformers have sought, however, has not been justice. It is sometimes called distributive jus­tice, but it should be called, in­stead, equality. The laws passed restricting the railroads have been animated by the notion that all shippers and passengers of the railroads should be treated equal­ly. They seem to think that each customer of the roads should be charged what it costs to provide the service, plus a "reasonable" profit. To calculate such a charge, it should be necessary only to fig­ure how much it costs to trans­port a given unit a certain dis­tance and then apportion this among the customers according to the number of units and dis­tance shipped.

Of course, no such calculation can be made. More precisely, if such a calculation were made it would spread disaster in every direction when applied. It could only be an average cost per-unit per-distance which would only by sheer luck be the actual cost of shipping one unit a given dis­tance. If such an average cost were then prescribed, it might be ex­pected to bankrupt every railroad in the country not only because the costs of providing rail service vary from one line to another and on the same line but also because they run counter to the whole purpose of the railroad. This is why the government programs have had such a deleterious effect; not because the programs have ever involved so simplistic an ap­proach as the above but because they have worked off modifications of it which ignored the nature of the services railroads perform.

First, it must be made clear who the railroads ultimately serve.

Just as in so many other busi­nesses, the railroads serve con­sumers. Who is the consumer in this case? In the case of goods, the consumer is the person who finally buys and uses them. Though the railroads do serve shippers, they do so only as an auxiliary function to serving the ultimate consumer. In the case of passen­gers, the consumer is directly the person who is traveling but it would be appropriate to describe those to whom he travels as being, wittingly or unwittingly, the ulti­mate consumers of this service.

The Right Place, the Right Time

In technical terms, what the railroads add is place value. In this respect, they are like all other means of transportation. The pur­pose of transportation is to bring goods and people together and to do so as quickly and inexpensively as possible. Ideally, a transporta­tion system would make available at one’s doorstep goods and people from all over the world upon com­mand, in an instant, and without differential charge based on dis­tance transported. As consumers, this is what we desire from trans­port. A student of the railroads described the service they provide in this way some time ago: "The sole reason why man uses the rail­way is that it is the most effective agency at his command for the an­nihilation of space and distance, and it is to be hoped that in the course of time the railway or some other means of transportation will become so efficient as actually to annihilate distance. The one thing that distinguishes the American railway managers from the rail­way managers of the rest of the world is the success with which they have relieved cities or places of production of disadvantages re­sulting from their location."¹

If railroads were to establish rates upon the basis of costs per-unit per-distance, the tendency would be to deny service to con­sumers which they are set up to provide and to do themselves out of most of their traffic. Producers at more distant points would have to pay more than those nearer by to get their produce to market, and if the distance were great the cost would become pro­hibitive. This is not what the con­sumer—that is, all of us—wants. We want as wide a selection of goods and services as possible. The crucial fact is that the railroads can operate effectively only by providing them for us. Hence, the interest of the consumer is identi­cal with that of the railroads. Some local producers, in a short­sighted way, have believed their interests to be at odds with the interests of the railroads—hence, with consumers—and have tried to prevent the railroads from pro­viding transport from distant points inexpensively.

The Economics of Railroading: the Nature of Competition

There are two basic reasons for the identity of interest between the railroad and the ultimate con­sumer: the particular exigencies of railroading and the nature of competition. Let us examine first the economics of railroading.

Railroads have unusually high fixed costs, more, as a rule, than any other means of transport, and probably as much or more than any other industry. Their fixed costs include such items as laying and maintaining tracks, building and keeping up passenger stations and freight depots, paying for switch yards, rights-of-way, bridges and crossings, rolling stock, safety devices, sidings, and such like. They are unusual, in America at any rate, in that they alone among the means of trans­port maintain the thoroughfares on which they travel. Wagons, boats, trucks, and planes rarely provide their own thoroughfares; waterways and highways are usu­ally provided at the public ex­pense, though some charge may be made for their use. Railroads usu­ally even own and operate their traffic signals, something unheard of in other large operations. Hence, their costs in preparation for operation are very high.

On the other hand, railroads have unusually low variable costs compared with other means of transport. That is, railroads can increase the amount of service provided with declining costs for each additional unit to a point much beyond what is common in other businesses. A train of fifty cars, say, can be hauled for very little more than one of ten cars. Moreover, the cost per mile trav­eled declines precipitately as the distance is extended, since most of the fixed cost is in loading, un­loading, and related activities. To put it another way, given the fixed costs and the fact that a train has been made up, each car added and each mile traveled costs less than the one before it. Railroad prac­tices can be correctly understood only in this context. Railroads have tremendous incentive to in­crease the length of their trains, the frequency of them, and dis­tance traveled. By so doing, they are enabled to recover their high fixed costs, take advantage of low variable costs, and increase their income. When they operate in this fashion, they are serving the con­sumer in the optimum manner, for he wants goods brought to him from great distances at low costs.

But, it may be objected, could the railroads not greatly increase their profits by basing their rates on per-unit per-distance traveled? Of course, they could in the ab­stract; that is, if the volume of freight would remain the same for the higher rates that it would for diminishing rates, they would have every reason to charge those at greater distances proportional­ly higher rates. The only thing is that the volume would not remain the same, and any railroad man­agement so shortsighted as to sup­pose that it would, might be ex­pected to bankrupt the company in short order. This brings us to the second reason for the identity of interest between railroad and con­sumer: competition.

Aspects of Competition

Few things can have been more misunderstood than the nature of the competition with which rail­roads have been confronted. It is quite common to treat the matter as if competition only existed—prior to automotive and aero­nautical transport—when two or more railroads connected with the same points. This is only one kind of competition and in many in­stances may be less important than others. One writer described the kinds of competition railroads encountered in this way: "compe­tition between carriers by rail, competition with rail and water lines, competition with water lines, competition between mar­kets, or competition of product with product."² To which it might be added that passenger traffic is in competition with such other modes of transportation as existed plus alternative uses of money.

Some examples may help to clar­ify the kinds of competition in­volved. Any given locale may be in competition with other locales for a particular market. For ex­ample, one might consider the market for grapefruit in Balti­more, Maryland. Domestic grape­fruit might be brought to Balti­more from Florida, from Texas, or from California. Florida is nearer than Texas to Baltimore, and both are nearer than Cali­fornia. Suppose there were only one railroad from California to Baltimore. It still could not charge whatever price suited it for haul­ing grapefruit. It would have to meet the rates of rail and ship lines from Florida and Texas. The same would be true, it must be clear, whether there were one or twenty lines from California to Baltimore.

Competing for Markets

The competition for markets is broader and more extensive than the above would indicate. The fol­lowing is a description of it re­garding other products and mar­kets:

This competition is national and international in scope; not only does the wheat of Dakota compete in Chi­cago with that of Kansas and Ne­braska, but the wheat of the United States competes in Liverpool with that of Canada, Russia, Argentine Republic and India…. The Pennsyl­vania and Virginia coal competes in New England with that from Nova Scotia; the various coal fields in the Alleghenies compete with each other; the Southern iron and Northern iron are competitors….³

This competition for market ap­plies even when only one railroad is involved. Distance from the market must be largely negated as a factor in charges for transpor­tation if those farther from the market are to compete with those nearer to the market. For ex­ample, if farmers near Pough­keepsie had to pay twice as much as those near Peekskill, if those near Albany four times as much as those from Poughkeepsie, those near Syracuse three times as much as those from Albany, to get milk delivered by railroad to New York City, the chances are good that milk from distant points would never have reached New York City. On the contrary, rates must be approximately the same from all these places to the destination. The railroads want to haul freight, and in order to make dis­tant commodities competitive with those nearby, they will charge less on many occasions than would seem to be warranted by the dis­tance.

Competition between products or services must also be taken into consideration. Not only are human wants extensive but also the means for gratifying them are numerous and diverse. The num­ber of foods which, either singly or in combination with a few others, will sustain life and health are so many as to be unnumbered. There are numerous fibers from which to make clothes, a great va­riety of building materials, a con­siderable number of fuels, and so on. If the price of any one of these is raised significantly, alternative means are likely to be used to gratify the want. For example, if oranges become more expensive, apples may be substituted. The consumption of commodities for which the demand is elastic will decline as the price rises, particu­larly if it rises in proportion to the prices of substitutes. This point is appropriate for passenger fares as well as freight rates. Whether one takes a trip, buys some stock, builds a new room on his house, purchases some new contraption, or what not, will be determined in part by relative cost as well as desire. Reduce the cost of travel, and the number of tra^ve^lers and trips may he expected to increase, other things being equal.

All sorts of economies come in­to play to check the desire of rail­road operators to arbitrarily set charges. It might be supposed, for example, that those within a com­munity served by only one line would be at the mercy of the rail­roads on incoming freight. It does not follow. "Backhauling," as it is called, is most important to rail­roads. The incentive is to haul loaded cars in both directions, and in order to do that, charges must be kept sufficiently low for goods coming in as well as those going out.

The Incentives to Serve

It should be clear from the above exposition, then, that from the nature of railroading and the competition encountered the rail­roads had great incentive to pro­vide extensive service, reduce the cost of transport, and serve the consumer in the best possible man­ner for the lowest practical price.

By so doing, they would be most likely to recover their fixed costs and to profit from their low vari­able costs. Any move toward high­er charges and the reduction of services would tend to reduce traffic, make it more difficult to meet costs, and work to the disad­vantage of the railroads. The his­torical record tends to substanti­ate what theory would predict. So long as the railroads were free to do so, they did extend their facil­ities, improve service, reduce costs, and lower their rates.

Most of the charges against the railroads of discriminating among customers as reasons for regula­tion are predicated on miscon­structions of the nature and pur­pose of railroading. Of course, railroads did and do discriminate among their customers. One writer put it this way some time ago:

Discrimination is the underlying principle of all railroad tariffs, whether they have been established by State railroad commissioners, or by the railroads themselves. This is so necessarily. Were it otherwise, railroads could not be successfully operated. Instead of promoting and facilitating commerce, they would hamper and obstruct it, and cause great injury to the public.⁴

Some of the reasons for this should now be easy to see. They discriminated between those distant from the market and those nearer by in order to make the more distant products competitive, between large shipping centers and small intermediate points be­cause of low variable costs, be­tween one product and another de­pending upon the particular exi­gencies, between those making large shipments and those making small ones because of various economies involved, and so on.

It was alleged that these dis­criminatory practices obliged small shippers from small com­munities not served by competi­tive lines to pay not only their own way but a part of that of those more favorably located as well. The way to check on this would be to see how much it would cost to provide service to small communities, intermediate points, and those near to market without the other traffic. It would not be difficult to see that in view of the high fixed costs, the low variable costs, and the income from large shipments over a long distance, the railroads would have to charge much more for local service than they did. There is some historical evidence to support this. As gov­ernment has tried to reduce such discriminations by regulation, the railroads have consistently re­duced their local service and dis­couraged small shipments.

Railroads also discriminated by giving free passes to some people. This practice should be considered as a not very subtle effort at pub­lic relations by the railroads which backfired. Free passes were frequently granted to clergymen, newspapermen, politicians, and anyone else in a strategic position to render favorable judgments on them. In effect, the railroads were lobbying to try to prevent puni­tive action by governments. Not only did the tactic fail but it be­came another source of discontent with the railroads. In this case, as in so many others, reformers turned the means by which a busi­ness attempted to defend itself from government interference in­to justification for further regu­lation.

Discrimination and Competition

Rebating was a kind of discrim­ination; but it should be discussed in connection with competition, to which we may now turn for an examination of the charges about it. Why would the railroads give rebates to certain shippers? Why would they not, instead, simply lower the charge? In the absence of government regulation, they could have charged any shipper whatever rate was mutually agree­able.

In the main, what led to rebat­ing before 1887—the year when the Interstate Commerce Act was passed—was the practice known as pooling. Pooling was a device got up by the railroads in a par­ticular area to establish rates be­tween competitive points and to avoid price competition among lines in direct competition with one another. There were two sorts of pools: those in which rates were agreed upon and the traffic divided according to some ratio among the railroads, and those in which receipts were divided among the roads according to some form­ula. Rebates were means by which railroads secretly competed with one another within a pool, though if the agreement called for a pool­ing of receipts the incentive to do this was greatly reduced.

Pools were not illegal according to the common law, which in the absence of positive legislation would generally prevail in the United States. The courts would not break them up; neither, how­ever, would they enforce the agreements. Pools had no more standing before the law than, say, did gambling debts. Pools were usually short-lived arrangements, but competing railroads were con­tinually trying to reorganize them after they broke up.

Why did railroad men organize pools? The answer is simple: in order to avoid the requirements of competition. Why did railroad men give rebates and withdraw from pools? The answer again is simple: in order to compete. To resolve this apparent contradic­tion, yet another facet of compe­tition must be examined along with the historical conditions within which the railroads were operating.

Let Others Compete

There is one side of competition that rarely draws comment. It is this: probably no one likes com­petition in his own particular un­dertaking. On the other hand, al­most anyone can be convinced of the desirability for others to com­pete. It is easy enough to under­stand why this is so. To compete means to offer as good or better services than others, to become and remain efficient, to stay abreast of the competitor’s meth­ods and technology, and to lose out when others can do the job better or less expensively. Interest groups usually arise from one of two (or both) reasons: to protect themselves from government, or to get some advantage from gov­ernment. One of the advantages—the central one—sought from gov­ernment—is to be relieved of the necessity of competition.

Reformers were not the only ones ambivalent about competi­tion; railroad men were, too. There is a considerable literature in the late nineteenth and early twentieth centuries, some portion of it in sympathy with the railroad­ers, detailing the "horrors" of competition and calling for gov­ernment action to abate it. Among the horrors attributed to competi­tion were rebating, rate wars, bankruptcies, and general instabil­ity. What many railroad men would have liked would have been for the government to enforce their pooling agreements as con­tracts, that pools be legalized. Much evidence was gathered which purported to prove that pools did not result in higher rates. Yet, every rebate granted tended to prove the opposite.

Mistaking Symptom for Cause

The facts used to support the claims about the horrors of com­petition were quite valid. There were rate wars, rebates, bankrupt­cies, and many railroads in shaky condition. To blame competition for these, however, is to mistake the symptom for the cause. Rate wars are bargain sales or clear­ance sales; such sales, if they are genuine, are the result of either overproducing or overpricing. It is generally agreed that there was much overbuilding of railroads. The main reason for this was gov­ernment aid. Several things may have contributed to prices being too high at any given time: pooling, too many roads serving a given area, or inefficiencies of some of the railroads. But one cause may well have led all the others: drastic reductions in the money supply. In such a case—as in the early 1870′s and early 1890′s—drastic reductions in rates would have to occur in order to continue to keep as much traffic as formerly.

Rate wars, rebates, instabilities, and financial failures were effects not causes. They were effects not of competition but of tamperings with the market, tamperings by governments and the railroads. Competition was the cure, the means by which the adjustments would be made to offset the inter­ferences, adjustments which would mean the triumph of the efficient, the reduction of rates, the consol­idation of lines into larger sys­tems, and the providing of the op­timum service to the consumer.

Those who proposed government regulation and restriction of the railroads were calling for com­bating phantom and illusion. They confused effects with causes and cures with disease. They misun­derstood the exigencies of rail­roading and the nature of com­petition. Their laws reflected this confusion and when put into effect produced the opposite of what should have been wanted.

Next: Early Regulation—1887-1918.

—FOOTNOTES—

¹ Hugo R. Meyer, Government Regu­lation of Railway Rates (New York: Macmillan, 1906), p. 361.

² Henry Fink, Regulation of Railway Rates on Interstate Freight Traffic (New York: The Evening Post Job Printing Office, 1905), pp. 9-10.

³ Charles S. Langsroth, Railroad Co­operation in the United States (Phila­delphia: University of Pennsylvania, 1899), p. 85.

⁴ Fink, op. cit., pp. 102-03.