Online Library of Liberty: Economics, vol. 2: Modern Economic Problems

[Back to Table of Contents]

CHAPTER 29

RAILROAD REGULATION

§1. Peculiar privileges of railroads. § 2. Public nature of the railroad. § 3. State railroad commissions. § 4. Consolidation and need of national regulation. § 5. The Interstate Commerce Act. § 6. The Commission’s powers strengthened. § 7. Fixed rates and declining net earnings. § 8. Federal control of railroads. § 9. Transportation Act of 1920. § 10. Significance of the Transportation Act.

§1. Peculiar privileges of railroads. The various grants of lands and money to the railroads make them other than mere private enterprises. Those in control of the railroads usually denied this and asserted the right to run “their own business” as they liked. They said that the bargain was a fair one, and was then closed. The public gave because it expected benefit; the corporation fulfilled its agreement by building the road. The terms of the charter, as granted, determined the rights of the public; but no new terms could later be read into it, even though the public came to see the question in a new light. Similar grants, though not so large, have been made to other industries. Sugar factories were given bounties; iron-forges and woolen mills were favored by tariffs; factories have been given, by competing cities, land and exemption from taxation; yet these enterprises have not on that account been treated, thereafter, in any exceptional way. So, it was said, the railroad was still merely a private business.

But the social answer is stronger than this. The privileges of railroads are greater in amount and more important in character than those granted to any ordinary private enterprise. The legislatures recognize constantly the peculiar public functions of the railroads. In other private enterprises investors take all the risk. Legislatures and courts recognize the duty of guarding, where possible, the investment of capital in railroads. Laws have been passed in several states to protect the railroads against ticket-scalping. Whenever the question comes before them, the courts maintain the right of the railroads to earn a fair dividend. Private enterprise has been invited to undertake a public work, yet public interests are paramount. The regulation of railroad rates is not a new condition read into railroad franchises, but is implied in the grant of a franchise to common carriers and is involved in the old English law of common carriers.

§ 2. Public nature of the railroad. As a result of a half-century of bitter experiences with the results of the private property conception of railroads, a growing part of the “public” began to have more definite opinions regarding the nature of the railroad business. That opinion by 1870 had begun to run about as follows. Railroads in our country are owned by private corporations and are managed by private citizens, not, as in some countries, by public officials. They have been built by private enterprise, in the interest of the investors, not as a charity or as a public benefaction. Railroadbuilding appears thus at first glance to be a case of free competition where public interests are served in the following of private interests. But, looked at more closely, it

Online Library of Liberty: Economics, vol. 2: Modern Economic Problems

may be seen to be in many ways different from the ordinary competitive business. Competition would make the building of railroads a matter of bargain with proprietors along the line, and an obdurate farmer could compel a long detour or could block the whole undertaking. But the public says: a public enterprise is of more importance than the interests of a single farmer. By charter or by franchise the railroad is granted the power of eminent domain, whereby the property of private citizens may be taken from them at an appraised valuation. The manufacturer, enjoying no such privilege, can only by ordinary purchase obtain a site urgently needed for his business. Why may the railway exercise the sovereign power of government as against the private property rights of others? Because the railway is peculiarly “affected with a public interest.” The primary object is not to favor the railroads, but to benefit the community. These charters and franchises are granted sparingly in most European countries. In this country they have been granted recklessly, often in general laws, by states keen in their rivalry for railroad extension. When thus great public privileges had been granted without reserve to private corporations, it was realized, too late in many cases, that a mistake had been made and that an impossible situation had been created.

If an extremely abstract view is taken, there is danger of losing sight of the real problem, which is that of harmonizing these two interests in thought and in public policy. Yet the extreme advocates of the private control of railroads for a long time resented indignantly any public interference with railroad rates and with railroad management as an infringement of individual liberty. This position often was inconsistently taken by those in whose interests free competition had been violently set aside at the very outset of railroad construction, and for whom governmental interference had made possible great fortunes. It has become generally recognized that the railroads ought not to be allowed to change from a public to a private character, just as it suits their convenience. True, they are private enterprises as regards the character of the investment, but they are public enterprises as to their privileges, functions, and obligations.

If there were none of these special reasons for the public control of railways, there is an all-sufficient general reason in the fact that a railroad is always, in some respects and to some degree, a monopoly. Therefore, the railroad problem may be viewed as but one aspect of the general problem of monopoly.

§ 3. State railroad commissions. When it became apparent that public and private interests in the railroads were so divergent, it still was not easy to determine how the public was to be safeguarded. At first some general conditions, such as maximum rates, were inserted in the laws and charters; but these were not adaptable to changing conditions and, for lack of administrative agents, could not be enforced. Some early efforts at state ownership were disastrous. The old law of common carriers gave to individual shippers an uncertain redress in the courts for unreasonable rates; but the remedy was costly because the aggrieved shipper had to employ counsel, to gather evidence, and to risk the penalty of failure; it was slow, for, while delay was death to the shipper’s business, cases hung for months or years in the courts; it was ineffectual, for, even when the case was won, the shipper was not repaid for all his losses, and the same discrimination could be immediately repeated against him and other shippers.

Online Library of Liberty: Economics, vol. 2: Modern Economic Problems

In the older eastern states, attempts to remedy these and other evils by creating some kind of a state railroad commission date back to the fifties of the last century. Massachusetts developed on the eve of the seventies (1869) a commission of the advisory or “weak type,” which investigated and made public the conditions, leaving to public opinion the correction of the evils. A number of the western states, notably Illinois and Iowa, developed in the seventies commissions of the “strong type,” with power to fix rates and to enforce their rulings. The commission principle, strongly opposed at first by the railroads, was upheld by the courts and became established public policy. By 1915 every state and the District of Columbia had a state commission.

As a remedy for railroad evils, however, the state commissions, strong as well as weak, were disappointing. It is true that from the first they did much to make the accounts of the railroads intelligible, something to make the local rates reasonable and subject to rule, and much to educate public sentiment. But it was difficult to get commissioners at once strong, able, and honest; the public did not know its own mind well enough to support the commissions properly; and the courts decided that state commissions could regulate only the traffic originating and ending within the state. After 1888 the state commissions more and more directed their activities toward the regulation of local utilities. In Wisconsin and in New York in 1907, in New Jersey in 1911, and in many other states since, the “railroad” commissions were replaced by “public utilities” or “public service” commissions, having control not only over the railroads but over street-railway, gas, electric-light, telephone, and some other corporations.

§ 4. Consolidation and need of national regulation. Before passing to the discussion of the next era of railway policy, reference should be made to the steady movement toward the consolidation of small railroad units into larger systems, for this was affecting greatly the character of the railroad problem. The early railroads, many of which were built in sections of a few miles in length, began to be united with many branches. The New York Central between Albany and Buffalo was a consolidation, by Commodore Vanderbilt, of sixteen short lines. The Pennsylvania system was formed, link by link, from scores of small roads.

Toward this result strong economic forces were working. Consolidation has many technical advantages: it saves time, reduces the unit cost of administration and of handling goods, gives better use of the rolling stock and of the terminal facilities of the railroads, and insures continuous train service. It has the advantages of other large production and the possible economies of the trusts. Most important, however, from the point of view of the railroads, is the prevention of competition and the making possible of higher rates and larger dividends. The statement that competition is not an effective regulator of railroads often is misunderstood to mean that it in no way acts on rates. It is true that competition between roads does not prevent discrimination and excessive charges between stations on one line only; but competition usually has acted powerfully at well-recognized “competing points.” The larger the area controlled by one management, the fewer are the competing points; the larger, therefore, is the power over the rate and the more completely the monopoly principle

Online Library of Liberty: Economics, vol. 2: Modern Economic Problems

applies. It is a grim jest to say that consolidation does not change the railroad situation as regards the question of rates.

§ 5. The Interstate Commerce Act. We now come to the third era of railroad policy, that of a weak and ineffective control by a federal agency. Public hostility to private railroad management was greatest in the regions where the most rapid building of roads occurred from 1866 to 1873. One center of grievances was in the “Granger states” of Illinois, Wisconsin, Kansas, Nebraska, Iowa, and Minnesota; another center was in the oil regions of Ohio and Pennsylvania. The eastern states were not without their troubles, for the report of the Hepburn Committee of the New York legislature in 1879 showed that discrimination between shippers prevailed to an almost incredible degree in every portion of New York state. When the courts, in 1886, decided that the greater portion of the railroad rates could not be treated by state commissions, national control was loudly demanded. Scores of bills were presented to Congress between 1870 and 1886, and, despite much opposition, the act creating the Interstate Commerce Commission was passed in 1887.

The act laid down some general rules: that rates should be just and reasonable; that railroads should not pool, or agree to divide, their earnings to avoid competition; that they should under similar conditions, and unless expressly excused, fix rates in accordance with the longand short-haul principle (to charge no more for a shorter distance than for a longer one on the same line and in the same direction, the shorter being included within the longer). The act provided for a commission of five men, to be appointed by the President, which might require uniform accounts from the railroads and which should enforce the provisions of the act. The commission in its earlier years gave promise of effectiveness, but its powers, as narrowly interpreted by the courts, proved inadequate to its assigned task. Court decisions paralyzed its activity, and the railroads in many cases refused to obey its orders. Competent authorities declared in 1901, after fourteen years of the Commission’s operation, that discrimination never had been worse, and a series of exposures of abuses strengthened the popular demand for stricter legislation. Weak federal regulation had been valuable as a means of educating public opinion, but had failed as a means of remedying railroad evils.

§ 6. The commission’s powers strengthened. The latest era, that of strong federal regulation, preluded by the passage of the Elkins Act in 1903, aimed at discrimination and rebates, began definitely with the Hepburn Act of 1906. The Commission was increased to seven members, its authority was extended to include express, sleepingcar, and other agencies of transportation, and it was given the power to fix maximum rates, not to be suspended by the courts without a hearing. It became thus unquestionably a commission of the “strong type.” It began to exercise its new powers with vigor, and the carriers reluctantly accepted its authority, as an evil less than that of “forty-nine masters.” Responsive to a calmer but insistent popular demand, further amendments were made by the Mann-Elkins Act of 1910, which strength-ended the longand short-haul clause, and gave to the Commission, among other new powers, that of suspending new rates proposed by carriers. A special Commerce Court of five judges was created with exclusive jurisdiction in certain classes of railroad cases, but this was abolished after a short trial.

Online Library of Liberty: Economics, vol. 2: Modern Economic Problems

Now began by the Commission an exercise of effective power. Complaints and prosecutions constantly brought to light many graver violations and many hidden abuses and minor violations of the act. Though an ideal condition might never be attained, the evils of favoritism by public carriers seemed in the way to be ended. The Commission, having absolute control over rates, kept them down. According to public opinion, this was the Commission’s chief duty.

lf1375-02_figure_048

Fig. 2, Chapter 29.—Decline of railroad rates, relative to prices and railway wages, 1905-1920.

Note: The main reason for the growing financial difficulties of the railroads, especially after 1915, is evident here. The increases in rates were tardy, and inadequate to keep pace with rising costs. The last large rate increase, effective in September 1920, occurred several months after wholesale prices had passed their peak and were rapidly falling, and traffic was declining.

§ 7. Fixed rates and declining net earnings. At this point a new feature appeared in the situation. The curve of general prices continued, with slight irregularities, to rise after 1897, and railroad wages had been about keeping pace, moving now a little behind and then ahead, as a result of concessions, of strikes, of threatened strikes, and of decisions in arbitration. Thus almost everything that railroads had to buy—repairs, equipment, materials, labor of all kinds, had been increasing, while the average of freight rates was somewhat decreasing.1 The result was decreasing railway net earnings, falling railway credit, rapid slackening of railway-building, and inadequate maintenance of existing equipment. Railroad facilities and capacity, despite substantial technical progress in some respects (size of engines, train loads, etc.), was not keeping pace with the growth of the population and of the business of the nation.

By 1914 the danger of this course began to be apparent to the public mind. The application of the roads for permission to raise various rates (in what was called, somewhat inaccurately, the “5 per cent case”) was still opposed by the irreconcilable opponents of the roads. Many state railroad commissions united to oppose the granting of the application, and Mr. Louis D. Brandeis, as special counsel for the Commission, urged in a brilliant brief, half sophistical, half sound, that all of the additional revenues needed could and should be obtained by further economies in railroad management. In July, 1914, the Commission granted a part of the railroads’ plea, the dissent of two members being on the ground that all was needed and should be granted. The Commission then by successive orders came over by the following December to the view of the minority, and granted further increases. Even this relief proved to be quite inadequate, as prices rose in 1915, making railway rates, relative to the monetary values of the goods transported, less than ever before. But in principle and as a precedent, this action of the Commission was important, for it reflected a change of public opinion. A good part of the public had begun to glimpse the truth that it is the duty of a public authority with absolute rate-fixing power to fix rates high enough as well as to keep them low enough; and they are not high enough if they do

Online Library of Liberty: Economics, vol. 2: Modern Economic Problems

not give a return sufficient to maintain the existing plant and to attract new investments.

lf1375-02_figure_049

Fig. 3, Chapter 29.—Decline of railroad net earnings, 1916-1921.

Note: The heavy line is a smoothed curve, showing the general trend of net earnings of a representative group of railroads; a general downward trend appears, only partially offset by successive rate increases.

§ 8. Federal control of railroads. Railway net earnings moved up2 and down in 1916, helped by the great growth of tonnage and hurt by further rise of prices and wages. Then came our entry into the war in April, 1917. At once the railroads united voluntarily in creating a Railroad War Board, seeking to put every facility of the railroads at the disposal of the government. The rolling stock and trackage, however, were quite inadequate to carry the war traffic, and, with a view to their more efficient use in the war, they were federalized by presidential proclamation in December, 1917 (under powers granted by an anticipatory law of August, 1916). The conditions and details were fixed by the Railroad Control Act of March, 1918. By this the roads were guaranteed while under government control net revenues based on the earnings of the three-year test period ending the preceding June. The roads were to be returned, not less than twenty-one months after the conclusion of peace, in as good condition as they were when taken. In every way possible, priority of shipment was given to materials for army and navy and to goods that had a more or less visible relation to the winning of the war. At the head of the federal “Railroad Administration” was the Secretary of the Treasury, who was clothed with well-nigh unlimited war-time powers, and in fact became the president of the consolidated railroads of America. Whenever he and his advisors felt it to be to the public interest, the division lines of private ownership were obliterated in a manner that was revolutionary in railroad practice. Palatial passenger terminals built by the enterprise of single companies were thrown open to the use of competing lines, equipment was interchanged, superfluous competing trains between large cities were discontinued, to the astonishment of those who cherished the old competitive conception of railroad operation. Despite heroic efforts, railroad operation at times nearly broke down, freight terminals were blocked for miles, and side-tracks were filled with loaded cars that could not be moved. In these conditions and with general prices and railroad wages rising, the net earnings fell short of the guaranties. In May, 1918, rates both for passengers and for freight were sharply advanced, freights by a flat 25 per cent, besides many other advances and reclassifications. This gave immediate relief, which helped to carry the railroads through to the end of federal control; but rising prices and wages again overtook the railroad receipts.

lf1375-02_figure_050

Fig. 4, Chapter 29.—Railroad wages compared with living costs, 1917 and succeeding years.

Online Library of Liberty: Economics, vol. 2: Modern Economic Problems

Note: Wages are average for each year, cost of living is of date December of each year. After the slump in prices in 1920, railroad wages remained relatively much higher than railroad rates and net earnings. These figures were presented by the railroads in their plea to the public for a lowering of wages, to show that railroad labor had virtually “profiteered” in the war conditions. In some details the spokesmen of the railroads question these figures, although the general trend is unquestioned.

§ 9. Transportation Act of 1920. After the armistice, the return of the railroads to private control became the subject of much discussion in financial and in political circles. Though railroad finances fared better after the increase of rates in May, 1918, net earnings fell again in the temporary business recession early in 1919, to rise again in the business boom of mid-1919; then, as a result of the continued rise of costs and wages, fell again nearly to zero by mid-1920. The Interstate Commerce Commission then granted a large increase of rates, both passenger and freight, effective in September, 1920. Meantime in February the “Transportation Act of 1920,” otherwise known as the Esch-Cummins Act, became law, returning the railroads to their owners March 1, 1920. This law necessarily postponed the task of “unscrambling” the railroad omelet and settling the government’s indebtedness to the several roads. But, more important for the future, amendment of the Interstate Commerce Act increased its membership to eleven, and in various ways implied a new, or advanced, view of the railroad problem. The chief new features are:3

1.Rates must be adequate to yield a fair return on the aggregate value of the property of the carriers, either in the entire country or in rate groups. This is assumed to be the first two years 5½ per cent (but may be ½ per cent more to make provision for improvements) on the valuation to be fixed by the Commission.

2.Net earnings of any carrier are to be limited to 6 per cent and one half of the excess, the other half to be paid to the Commission for a contingent fund to be lent to weaker roads or used in other ways helpful to the railway conditions.

3.All the railroads are to be consolidated into a limited number of systems by a plan to be prepared by the Commission, but this plan as yet is only to be recommended, not enforced upon the carriers. Within each system, consolidation, mergers, division of traffic, and pooling may be authorized by the Commission.

4.Joint use of terminals may be required by the Commission.

5.Stricter control is to be exercised over railroad policies, including security issues, routing of traffic, car service, discrimination, and other features.

§ 10. Significance of the Transportation Act. This act was almost unanimously conceded, by those of divergent views, to contain many commendable features, and is generally characterized as the last trial of private ownership as well by those who favor as by those who would deplore such an outcome. It brings to an end the régime of private railway ownership and management in the United States, in which private interests were uppermost for good and for evil. In that period constructive minds have built great railroad systems and have developed marvelously the technic of railroad