Job Name:2081773 Date:14-12-05 PDF Page:2081773pbc.p1.pdf Color: Cyan Magenta Yellow Black FREIGHT TRANSPORTATION REGULATION Evaluative Studies

This series of studies seeks to bring about greater understanding and promote continuing review of the activities and functions of the federal government. Each study focuses on a specific program, evaluating its cost and effi­ ciency, the extent to which it achieves its objectives, and the major alternative means­ public and private-for reaching those objec­ tives. Yale Brozen, professor of economics at the University of Chicago and an adjunct scholar of the American Enterprise Institute for Public Policy Research, is the director of the program. FREIGHT TRANSPORTATION REGULATION Surface freight and the Interstate Commerce Commission

Thomas Gale Moore

American Enterprise Institute for Public Policy Research Washington, D. C. Distributed to the Trade by National Book Network, 152.00 NBN Way, Blue Ridge Summit, PA 172.14. To order call toll free 1-800-462.-642.0 or 1-717-794-3800. For all other inquiries please contact the AEI Press, 1150 Seventeenth Street, N.W., Washington, D.C. 2.0036 or call 1-800-862.-5801.

Thomas Gale Moore is a professor of economics at Michigan State University and an adjunct scholar of the American Enterprise Institute.

Evaluative Studies 3, November 1972 Second printing, December 1974 Third printing, February 1979 Library of Congress Catalog Card No. L.c. 72·93994 © 1972 by American Enterprise Institute for Public Policy Research. Washington, D.C. Permission to quote from or to reproduce materials in this publication is granted when due acknowledgment is made. Printed in the United States of America CONTENTS

INTRODUCTION ...... 1

I BACKGROUND OF REGULATION 3 Railroad Interest in Government Help 4 Shipper Support for Government Control ...... 6 Economic.Justification for Regulation...... 9

II THE INTERSTATE COMMERCE ACT ...... 11 The Act of 1887 ...... 11 Early Actions of the Commission ...... 13 The Breakdown of Regulation ...... 14 Elkins Act 14 Hepburn Act 15 Mann-Elkins Act of 1910 16 Transportation Act of 1920 18 The Depression and the Railroads ...... 23

III THE DEVELOPMENT OF MULTI-MODAL REGULATION 25 Motor Carrier Regulation ...... 25 Water Carrier Regulation ...... 31 Freight Forwarder Regulation 32 Intermodal Regulation 36 Reed-Bulwinkle Act 37 Transportation Act of 1958 38 IV REGULATORY PRACTICES ...... 41 Entry . .. 41 Rates . .. 48 Service 55 Mergers . .. 64

V EFFECTS OF REGULATION ...... 71 Prices 71 Service...... 75 Market Share 77 Cost to the Economy 79

VI ALTERNATIVES 83 Surface Transportation Act of 1971 83 Transportation Regulatory Modernization Act 86 Total Deregulation ...... 90

NOTES 95 INTRODUCTION

The federal government has regulated U.S. transportation with vary­ ing degrees of stringency since 1887 while state efforts to control rates go back to very early periods. In fact, regulation of transpor­ tation in the form of setting legal maxiInum rates for toll roads probably goes back to colonial days. Systematic national regulation, however, originated with the Act to Regulate Commerce of 1887, which established the Interstate Commerce Commission. From that time to this, regulation of transportation has grown and multiplied in the United States. Recently, there has been increasing agitation to modify or elimi­ nate much of the regulation. Proponents of a free market in trans­ portation have claimed that such markets will provide major savings to shippers, consumers, and carriers. In their view, innovation would be more rapid, service would improve, and costs would decrease in the absence of regulation. The recent bankruptcy of the Penn-Central Railroad, the poor financial condition of other roads, the weak earn­ ings of major airlines in recent years and the decreasingly competi­ tive position of our merchant marine all make it imperative that a thorough examination of the regulatory structure be carried out. It may be that much of the weakness of the transportation indus­ tries can be attributed to regulation. It has been argued that regula­ tion imposes large costs on carriers, shippers, and consumers and, by encouraging cartel behavior, causes higher expenses, less flexi­ bility and, in the long run, reduced profits for the carriers themselves. On the other hand, advocates of regulation have urged that the

I would like to thank Yale Brazen, James C. Miller, and George Hilton not only for reading the manuscript but especially for their valuable insights and suggestions.

1 regulatory agencies' powers be incl'eased to deal with the obvious weaknesses of the current system. It has been shown that regulation falls with unequal vigor on different modes and that this, in turn, distorts transportation decisions. Advocates of regulation have urged that it be extended to the exempt areas, and that the same controls be applied equally to all areas. In addition, many have claimed that without regulation the transportation industries would be chaotic, competition would be cutthroat, and while prices might plummet temporarily, they would subsequently rise to great heights. The end result would be that the consumer would suffer through poor service, fluctuating rates, price discrimination, and inefficiency. Given the poor financial position of the transportation industry and the general agreement that regulation, whether too little or too much, has a role to play, major efforts are currently being made to restructure the regulatory framework. Recently, Senator Vance Hartke (D-Ind.) introduced a bill entitled the Surface Transportation Act of 1972 which would have provided equipment subsidies, would have brought under regulation some now exempt commodities, and would have increased regulation of water carriers. This bill was supported and developed by the American Trucking i\ssociations, the Association of American Railroads, and the \Vater Transport Association. On the other side, the Nixon administration introduced a bill to move toward limited deregulation. This proposal received support from academic economists, shippers, and consumer groups. This paper will explore the issue in general terms, while not dealing explicitly with either the administration's bill or the Hartke bill. Although many of the arguments are applicable to other sectors of transportation, the discussion will be confined to the regulation of surface freight transportation with the exception of pipeline carriage.

2 CHAPTER I

BACKGROUND OF REGULATION

The current status of regulation in the United States is intelligible only in the context of its origins. While the Interstate Commerce Commission was established in 1887, its origins go back to the early years of railroading. After the Civil War, as railroads spread across the nation tying cities and hamlets together, competition between parallel lines began to develop. Almost simultaneously with the development of commercial rivalry came efforts to eliminate com­ petition or reduce its magnitude.1 Cartel-type activity between railroads goes back to at least the Iowa Pool of 1870 and price collusion originates even earlier. By 1870, freight agents from the New York Central and the Pennsylvania Railroad were meeting to agree on rates from Chicago to the East Coast. Although there were only two railroads, the New York Central and the Pennsylvania, operating over the entire route between Chi­ cago and the Northeast, the Erie Railroad carried freight between New York City, Buffalo, and Cincinnati. At the same time, the Baltimore and Ohio Railroad ran between Baltimore and Pittsburgh with an extension to Columbus and Sandusky, Ohio on Lake Erie. With only two railroads competing on the entire eastbound route out of Chicago, and with the major flow of freight being to the coast, eastbound rates were generally adhered to. On the other hand, since there was considerable excess capacity on the return trip, westbound rates were often cut below agreed-to levels. Even though agreed-upon rates were generally adhered to on the eastbound traffic, on routes where there was competition, posted rates were often considerably less than where there was no com­ petition. For example, the Erie Railroad, which ran from New York City to Buffalo and served intermediate points, charged 29¢ per

3 hundred pounds for the fourth class rate on the competitive route from New York City to Buffalo, a distance of 379 miles. but charged 35(' per hundred pounds between New York City and ,L\ddison (330 miles) and 36(' per hundred pounds between New York City and Bath, New York (350 miles). On both of the shorter routes the Erie had a monopoly.:! Coincidental with the establishment of one of thp first formal cartels in October 1874-the Western Railroad Bureau-the B & 0 Railroad extended its lines to Chicago. The Baltimore and Ohio at first refused to join the Western Railroad Bureau and offered lower freight rates than the cartel had posted. As a consequence, the posted rate from Chicago to the East Coast fell from 56(' to 40,1. and indica­ tions were that actual rates paid were reduced considnrably below tha1.;; Shortly thereafter an attempt was made to stabilize this trans­ portation market with the establishment, under the direction of Colonel Albert Fink, of a pool to assure each road a certain propor­ tion of the westbound traffic. Unfortunately for the railroads, pools generally did not work long and this case was no exception. New competitors extended their lines to the Middle West and offered lower rates to attract a share of the market. During the 1870s and 1880s competition became widespread in railroading. For example, by 1880 shippers in S1. Louis and Atlanta had 20 railroads operating between the two cities.-! Although eight pools were established by 1879 to stabilize competition, all but one quickly failed.:-' Major pools included the Iowa Pool, which func­ tioned from 1870 to 1874, the Western Railroad Bureau, which lasted for six months during 1874-1875, the Southwestern Railroad Associa­ tion, which maintained prices for the two years 1876 to 1878, and the Eastern Trunkline Association, which survived three or four n10nths in 1877. The only truly successful pool was the Southern Railway and Steamship Association, which stabilized prices for a decade from 1876 to 1886.

Railroad Interest in Government Help

With the general failure of self-policing n1ethods-pools and cartel agreements-railroads began to search for other alternatives to sta­ bilize rates and increase their profitability. By the middle of the 1880s, a few of the leaders of the railroad industry began to recognize that government intervention might be necessary if the railroads ""Are to increase their profitability by preventing rate cutting. Many of the railroads already had experience with state regula­ tion, as state commissions had been operating in New England since

4 well before the Civil War. A major benefit of the New England regulatory commissions had been protection of the railroads from the wrath of farmers who often felt that the railroads were exploiting agricultural interests. That train men were not hostile to regulatory commissions is suggested by the fact that the chief architect of a revitalized Massachusetts commission, Charles Francis Adams, Jr., went on to become a pool arbitrator and eventually president of the f Union Pacific Railroad. ) In the late 1870s and early 1880s, the opinion of railroad execu­ tives on the desirability of federal regulation was swiftly changing, as can be seen from the following references. Chauncy M. DuPrew, attorney for the New York Central, and who had opposed commission regulation for years, admitted that he "became convinced of the necessity ... [of such regulation] for the protection of both the public and the railroads...." 7 In 1879, J. W. Midgley, chairman of the Southwestern Railroad Association, wrote: I am strongly of the opinion that special authority is neces­ sary to give permanence and assurance to apportionment schemes. Such result would be desirable not less to the public than to the railroads; and when, by the proper repre­ sentation, this is made manifest, there should be no diffi­ culty in securing the necessary legislation. 8 In 1882, Colonel Fink testified before the House Commerce Com­ mittee: Another method that could be adopted by the government is to enforce the tariffs established by the railroads and approved of as reasonable and just by the government. ... Some of the provisions of the "Reagan Bill," with some modifications, could, if applied, aid the railroad companies in carrying out their plans, but they could not be effectively applied without the cooperation of the railroads.... I am free to say, however, that I have little faith that any law prohibiting the payment of rebates will be of much use.... Still a law of this kind could do no harm; it would aid me in performing the duties imposed upon me by the associated roads of the Joint Executive Committee.n The Vice President of the Pennsylvania Railroad, John P. Green, agreed that a large majority of the railroads in the UnIted States would be delighted if a railroad commission or any other power

5 could make rates upon their traffic which would ensure them six percent dividends, and I have no doubt that with such a guarantee, they would be very glad to come under the direct supervision and operation of the National Gov­ ernment.10

On March 1, 1884, Charles Francis Adams, Jr., author of a state regulatory act and the president of the Union Pacific Railroad, wrote to Representative John D. Long of Massachusetts: If you could only get an efficient Board of Commissioners, they could work out of it [a regulatory bill] whatever was necessary. No matter what sort of bill you have, everything depends upon the men who, so to speak, are inside of it, and who are to make it work. In the hands of the right men, any bill would produce the desired results....11

In 1876 the first significant federal railroad regulation bill was introduced by Representative James Hopkins of Pittsburgh for the Independent Oil Producers. This bill, drafted by an attorney for the Philadelphia and Reading Railroad, forbade rebates and price dis­ crimination. The proposed legislation was in the interest of both the railroads and some shippers. Rebates and price discrimination are objectionable to cartel members since such practices reflect cheating and lead to a breakdown of cartel pricing. Normally there is little incentive for a cartel member to publish lower rates since competitors can quickly match the new charges, with the result that little extra business will be gained by reducing prices. However, secret rate cutting, which normally takes the form of reducing charges to select potential customers, can be highly profitable to an unfaithful cartel member. The longer it takes other firms in the cartel to discover that one firm has reduced its charges the more profitable the cheating will be.

Shipper Support for Government Control

Legislation forbidding rebates and price discrimination was also supported by numerous shippers which had also objected to rebating and the consequent price discrimination since at times they found that competitors received lower rates than they did. Often shippers are less interested in the level of rates than in whether their competitors are being charged less. If one shipper consistently receives lower rates than a competitor, the favored firm has a competitive edge. Thus, in the late nineteenth century there

6 was, and for that matter there continues to be, considerable shipper support for prohibiting discrimination and rebates that might, at least on a random basis, adversely affect unlucky or unfavorably situated firms. Moreover, it is generally true that businessmen do not like competition within their own industry. The fewer areas in which they have to compete, the less worry and risk that they will make wrong decisions and suffer large losses. In the nineteenth century, as in the latter half of the twentieth century, competition was very vigorous in many sectors. If competition could be eliminated or reduced in one major area such as shipping, a possible lever that competitors might use to advantage over another firm would be eliminated. Thus, throughout the history of federal regulation of transportation, shippers have taken an ambiguous position. Although many have seen that regulation tends to foster higher rates and worse service to their long-run detriment, they have also seen that it tends to produce uniform rates for particular classes of customers. Thus, in 1876, it was quite reasonable for the independent oil producers to favor and sponsor a bill designed to prohibit rebates and price discrimination. The major competitor of the independent oil producers was Standard Oil, which, being the largest firm in the industry with almost 90 percent of the refining capacity in the United States, was in a position to demand and secure rebates. The bill of 1876, therefore, was in part an anti-Standard Oil effort as well as being supported by many railroads to help stabilize price agreements. The Reagan bill, a very similar bill, introduced in 1877, included an anti-pooling clause. While the railroads did not favor the anti­ pooling provision, the other provisions of the bill were consistent with their interests. At the same time, the National Grange, reflecting farm unhappi­ ness with the railroads, agitated for regulation. Growers believed that railroads often exploited them since those farmers served by only one line often had to pay significantly higher shipping charges than those served by several. In addition, the sporadic establishment of cartel rates, followed after an interval by the breakdown of agreed-upon charges led to large fluctuations in transportation charges. As Table 1 indicates, the rate fluctuations were sharp and major. As the net receipts of farmers depended on the price for their products in the consuming markets minus transportation charges, the varying transportation charges added to agricultural price uncertainty and fluctuations. As was pointed out above, higher rates often were charged for shipments to and from small communities than for shipments travel-

7 Table 1 FIRST CLASS NEW YORK-CHICAGO FREIGHT RATES DURING 1869 Cents Per Cents Per Date Hundred Pounds Date Hundred Pounds

February 4 188 August 23 38 18 45 30 43 24 40 September 22 40 March 15 160 24 35 July 1 188 30 30 31 70 October 4 50 August 2 45 9 75 4 40 13 125 5 30 November 1 140 7 25 29 150

Source: D. Phillip Locklin, Economics of Transportation, 6th ed. (Homewood, Illinois: Richard D. Irwin, Inc., 1966), p. 293. ing farther between major hubs. This, of course, engendered con­ siderable hostility from merchants, manufacturers, and especially farmers located near communities served by only one road. While the consequent demands for controls are understandable, the cost to the economy as a whole of high rates for short hauls and low rates for competitive long hauls may have been relatively small. In the main, the effect of such discriminatory rates was to reduce any locational advantage of one-railroad communities. For example, shipping charges from many small towns in Pennsylvania and New York were higher to the East Coast than from the Middle West, but the major effect of this was to eliminate the advantage of being closer to the eastern seaboard. The railroads were always con­ strained not to' push rates so high that shippers would be forced out of business. The net result of this price discrimination, there­ fore, was to reduce the income of Pennsylvania and New York farmers, 'and thus the value of their land, while at the same time improving the income of those further west as well as the income of the stockholders of major railroads. While little misallocation of resources in the economy probably resulted from this type of dis­ crimination, although land values were changed, shippers from com­ munities served by only one railroad stood to gain considerably from the establishment of regulation that would either lower their rates or raise long-haul rates and thus improve their competitive position.

8 Economic Justification for Regulation

The traditional explanation for the establishment of regulation of transportation is that railroads in the nineteenth century were subject to extensive economies of scale, implying that they were natural monopolies. As natural monopolies, it is argued they were often in the position to exploit their monopoly position by charging prices vastly in excess of their costs, but often with the result of attracting additional competitors. As a result, competition allegedly became cutthroat and unstable, with prices declining and losses inflicted generally on all participants. While this is a possible explanation for the establishment of the Interstate Commerce Commission, many such characteristics found in the railroad industry also existed at the same time in the steel industry. For example, there were continued efforts by steel execu­ tives to establish uniform industry-wide prices, and, as in the railroad industry, there were continued episodes of price cutting and cheat­ ing, with the result that prices declined over the period. While com­ petition did not seem to have produced stable prices in the steel industry, it did not lead to cutthroat competition and widespread bankruptcy. No doubt the steel industry would have also appreci­ ated government help in stabilizing its rates. Unfortunately for the steel industry and probably fortunately for the rest of us, customers were not as interested in stable steel prices as they were in stable transportation costs, with the result that there was insufficient agita­ tion to produce regulation of steel, while there was enough to lead to the regulation of the railroads. Spann and Erickson have studied the operating costs of rail­ roads in the nineteenth century and concluded that for medium-size railroads, lower costs were not functions of larger size.12 They also point out that if there were substantial economies of scale, mergers would have been profitable and a trend towards consolidation of the railroad industry should have been evidenced. However, during this period there was very little merger activity in the railroad industry, especially among the larger and medium-size roads. In addition, Spann and Erickson point out that if railroading had been subject to large economies of scale, the largest roads, by having a cost advantage, should have grown faster than the smallest ones. They didn't. In fact, they tended to grow more slowly. Their evi­ dence, then, supports the proposition that railroading was not sub­ ject to economies of scale but was in fact a constant-cost industry. Of course, in certain specific small-haul, short-haul markets, railroads were in fact natural monopolies. There was some minimum

9 shipping-market size below which operations by more than une rail­ road would inflate costs, leading to cutthroat competition followed by a natural monopoly. This minimum market size' was sufficiently large that many small communities were in fact captives of single railroads.

10 CHAPTER II

THE INTERSTATE COMMERCE ACT

With broad support from the railroads, agricultural interests, and some shippers and merchants, the Interstate Commerce Act passed early in 1887. Upon enactment, President Grover Cleveland ap­ pointed Thomas M. Cooley, one of the most "conservative" railroad men, as first chairman of the Interstate Commerce Commission (ICC). He was an experienced pool arbitrator, a receiver of the Wabash Railroad, a member of a railroad arbitration committee, and while he had opposed federal regulation for years, he had become an advo­ cate of the legalization of pooling with public sanctions and control. Other members of the commission were William Morrison, an undistinguished Democratic politician; Walter L. Brag, also a Demo­ cratic politician who had been on the Alabama Railroad Commission; Augustus Schoonmaker, a railroad attorney; and Aldace F. Walker, who later went on to be chairman of the board of the Atchison, Topeka & Santa Fe Railroad. Cleveland's appointments to the newly formed commission could hardly have been more pro-railroad than if they had been picked by Vanderbilt himself in the board room of the New York Central.

The Act of 1887

The Interstate Commerce Act as signed by President Cleveland in 1887 had numerous sections; seven of these were important in terms of their economic impact. Section I provided that all charges be reasonable and just, and that every unjust and unreasonable charge was prohibited and declared unlawful. By failing to define a reason­ able or just charge, the act in effect entrusted the interpretation to the

11 ICC and the federal courts. Since Section I was so "ague, it was eventually emasculated by the courts, with the result that by 1897 the ICC abandoned attempting to regulate rates under its authority. Section II prohibited discrimination between persons as well as barring rebates to shippers. As mentioned above, such prohibitions stabilize cartel arrangements and reduce competitive pressures for shippers, while simultaneously benefiting captive shippers-those who face a monopolist. Section III was primarily intended to benefit Ne\v York mer­ chants by prohibiting geographical discrimination. Effectively en­ forced, this would have also helped stabilize any cartel by preventing a railroad operating between the Middle West and the South Atlantic states from undercutting a road operating between the Middle West and the North Atlantic states. Section IV contained the famous "long-and-short-haul clause" prohibiting a higher price for short-haul transportation than for a longer haul, over the same line, in the same direction, for like goods and under substantially similar circumstances and conditions-unless the ICC authorized an exemption. Although a major effect of this provision was to help stabilize long-haul rates, since a cut in long­ haul rates might require a reduction in short-haul charges, it also benefited those shippers closer to markets by compelling either a reduction in their freight rates or a rise in long-haul competitive rates. Section VI required the publication of all rates, a necessity that facilitated the enforcement of cartel agreed-upon charges. Railroads could no longer maintain secret rates and offer concessions to preferred customers to stimulate additional business. The obligation to publish tariff schedules, giving immediate notification of rate reductions to both competitors and shippers, gave all railroads an opportunity to match any lower charges, thus diluting the profitability of undercutting established rates. Section XX provided for collection of information on rates or any other information needed. Such information was necessary if the ICC was to ensure that railroads were abiding by their published rates. This section, as well as the other sections referred to above, was important in facilitating the commission's efforts to stabilize charges. Section V, the only major section that was not designed to encourage cartel activities, prohibited pooling of freight or earnings. As might be expected, this section had been opposed by railroad spokesmen, including the first chairman of the commission.

12 Early Actions of the Commission

The ICC quickly took a flexible view of Section IV, the long-and­ short-haul clause, by deciding that temporary relief would be granted to all applicants for exemption from the long-and-short-haul clause so that "harmful results from a sudden change in the law might thereby, to some extent, be averted." 1 In general, though, the effect of Section IV was to reduce some short-haul rates by about 15 to 30 percent and to raise long-haul rates so that they were in conformity with the law. MacAvoy estimated that regulation led to about a 6¢ per hundred pounds increase in long-haul rates between Chicago and the East Coast from a level of about 14¢ prior to the establish­ ment of the ICC. 2 In other words, while short-haul rates were reduced by about 15 to 30 percent, the more important long-haul rates increased almost 50 percent. In September of 1887, the Presi­ dent of the Chicago, Burlington and Quincy Railroad Company wrote: If the roads east of Chicago and St. Louis are maintaining tariff rates now, while, before the law, they did not maintain traffic rates, then the country west of Chicago and St. Louis, taken as a whole, is paying more for transportation between these points and the seaboard than it did formerly.3 By ruling that only permanent rate changes were reasonable, the commission discouraged sporadic rate cutting and helped to stabilize price agreements, since a temporary reduction in charges designed to undercut an established charge was no longer legal. The commission, for a time at least, seems to have been successful. MacAvoy, in his study of the ICC's formation, found that cartel cheating became considerably less prevalent after the establishment of the ICC. 4 Less than a year after the establishment of the commission, while the transportation journals were heaping praise on the ICC and the "honest men who ran it," the railroads were revamping their freight classifications, raising their long-haul rates, eliminating free passes and increasing their less-than-carload rates. Within a few years, it was apparent to all that the commission was favoring the railroads with the effect of producing higher rates for almost all shippers. In 1890 the Detroit Board of Trade wrote Congress that the act should be repealed since its main effect was to protect the rail­ roads and their rates. Businessmen, boards of trade, chambers of commerce throughout the West and Middle West sent similar demands for the repeal of Section IV. Even farmers found that the

13 act had not realized their expectations and joined the clamor for repeal. Spann and Erickson, who evaluated the overall effect of the ICC, found that during the period 1887 to 1893 the commission success­ fully maintained the railroad cartels with the result that rates were lower for short-haul traffic and higher for long-haul. Balancing out the gains to the short haulers with the loss to the long haulers, they concluded that the net loss to the economy as a whole ranged between $4.3 million and $19.1 million per year.3

The Breakdown of Regulation

Unfortunately for the railroads, the courts soon decided a number of cases that led to a considerable weakening of the ICC's control. In 1892 and 1893 the courts held that the long-and-short-haul clause related only to traffic over a single road and that a higher joint rate for a short distance compared to a longer one was legal. The final blow was the Troy Decision in 1897, which held the differences in competitive conditions constituted "circumstances and conditions ... substantially dissimilar to relieve the carriers from the charges preferred against them "G But only when competitive conditions differed would a railroad charge less for a long-haul than for a short-haul.

Elkins Act

With the failure of regulation, rebating, discounting, and secret price­ cutting became widespread. Small merchants formed a lobby, called the Interstate Commerce Law Convention, which urged Congress to pass stronger legislation against rebating and price cutting. Their aim was also supported by some railroad men who wan1ed an end to such tactics. Congress responded with the Elkins Anti-Rebating Act of 1903, written two years earlier by James A. Logan, general solici­ tor of the Pennsylvania Railroad. This act contained four provisions: (1) A railroad corporation was liable for prosecution on account of unlawful discrimination and concessions. (The courts had earlier held in several cases that a railroad could not be charged with violating the law-only the officers, employees, or agents of a railroad could be prosecuted.) (2) It became unlawful not only for shippers to receive rebates or cOJ"lcessions but even to solicit such favorable treatment. (3) De­ partures from published rates became a misdemeanor. (Prior to the

14 enactment of the Elkins Act the courts had refused to punish or prohibit deviations from published rates unless such deviations resulted in discrimination.) (4) The courts were authorized to enjoin carriers upon proof of misconduct of unlawful discrimination or departure from published rates. From the point of view of the railroads, the Elkins Act was a giant step towards stabilizing rates, preventing rebating, and violating understood rate agreements. While the connection cannot be proven, price cutting did become less prevalent and railroad earnings did improve after passage of the act.

Hepburn Act

Yet passage of the Elkins Act did not completely still shipper demand for more legislation, nor did it completely prevent price competition. Railroads were still free to set their rates as high or as low as they wanted, subject only to the provisions that they not be unduly discriminatory and that they be published. Shortly after the passage of the Elkins Act, President Roosevelt, in a message to Congress, took up a demand by shippers for more legislation dealing with railroads, including the idea that the com­ mission be given the power to fix actual rates. This proposal did not meet with industry hostility. Railroad executives had in the past expressed interest in giving the commission power to establish rates. (The first draft of the Elkins Bill, written by an official of the Penn­ sylvania Railroad, included a provision for ICC rate setting.) In fact, during the period of Cooley's chairmanship, when the other commis­ sioners were also very pro-railroad, the ICC had fixed rates. (In 1897, after the ICC had exercised this power for a decade, the courts held that this exceeded its authority.) Clearly, many railroad men were not opposed to, and in some cases even supported, granting the commission power to establish charges. In general, in the hands of a friendly ICC and with provisions for judicial review if the commis­ sion became overzealous, the railroads did not fear any such provision. In this context, the Hepburn Act of 1906, a piece of legislation which has sometimes inaccurately been considered anti-railroad, was passed. While it was not quite as beneficial to the railroad industry as the Elkins Act, it certainly was not widely opposed by the train men. It extended ICC control to express companies, sleeping car companies, and oil pipelines. Bringing these sectors of the industry under control enabled the commission to control rates throughout the railroad industry more effectively. It also granted to the com-

15 mISSIon the power to prescribe maximum rates upon finding that existing rates were unlawful. The commission was also given power over through rates and joint rates, closing a loophole in the law that permitted some rate competition. And, even though since 1889 railroads had been required to give three days notice before any reduction in rates and ten days notice before any increase in rates, the Hepburn Act made thirty-days notice mandatory for all rate changes. This requirement helped stabilize rates. The Hepburn Act also prohibited the granting of free passes except to specified groups, thus further reducing the scope of price discrimination available to a railroad. Another provision of the act was the so-called "commodities clause." A number of coal-hauling roads had substantial coal interests themselves. Such joint ownership of railroads and coal fields made the enforcement of established freight charges impossible. If such joint ownership were not to be used as a method of undercutting cartel rates to the railroad coal subsidiaries, some liInitation was necessary. The commodities clause, a result, at least partially, of this situation, prohibited railroads from transporting articles they had produced or had an interest in, except for lumber. The Hepburn Act also increased the penalty for rebating, aug­ mented the right of the commission to require detailed data from railroads, and reinforced the power of the commission to enforce its orders on the carriers. All three of these provisions, of course, strengthened the ICC's authority to control competitive behavior.

Mann-Elkins Act of 1910

The Hepburn Act did not eliminate the agitation for Dlore railroad legislation. The railroads still wanted additional protection. In par­ ticular, they wanted legislation banning state regulation and putting all regulation at the federal level. State regulation was often being used to hold down rates in intrastate commerce. Another problem the railroads wanted dealt with had to do with commodity classification. While under the Hepburn Act, the ICC had control over rates, it did not have any control over commodity classification, and thus there was ample room for railroads, by reclas­ sifying items, to reduce charges effectively to favored customers. Transportation men, therefore, wanted the ICC to have the power to specify a uniform commodity classification. Even though the com­ mission had generally been in friendly hands, the railroads feared that the ICC could be used to hurt them, so rail executives wanted a commerce court to appeal undesirable ICC decisions.

16 Shippers also wanted to amend the act. Shippers could protest rates only after they had gone into effect, and often by the time the case was decided, the damage was already done with those who had been adversely affected having disappeared. Thus, shippers wanted the ICC to have the power to suspend rates until a determina­ tion was made as to their legality. The result of these requests for legislation was the Mann-Elkins Act of 1910, which had six significant provisions: (1) The ICC was authorized to suspend proposed changes in railroad rates for 120 days with an extension of up to six months. While this provision had been demanded by shippers, it clearly could, and would, be used by one railroad to prevent another railroad from reducing its rates for a considerable time. (2) The ICC was given control over the classification of freight. (3) Shippers were empowered to designate routes over which their commodities would move. (4) The long-and­ short-haul clause, which had been struck down effectively by the courts in the late 1890s, was reinvigorated by striking out the phrase "under substantially similar circumstances and conditions." As a result, competition of water carriers would no longer be considered a justification for lower rates on long-haul traffic on the grounds that conditions were not substantially similar. However, the com­ mission could still waive the Section IV provision if it found it desirable. (5) The long-and-short-haul provision was amended in a significant manner to specify that if a carrier reduced rates in order to compete with water routes, it might not increase them unless the commission found the increase to rest on changed conditions other than the elimination of water carriers. This amendment reflected the first effort by Congress to protect intermodal competition. As such, it was the forerunner of a great deal of future transportation legislation. (6) A commerce court was established to handle appeals from commission rulings. This commerce court turned out to be even more pro-railroad than the commission, and in 1915, after a series of scandals, Congress abolished it. The Mann-Elkins Act contained provisions desirable to the rail­ roads, such as ICC control over the classification of rates, a rein­ vigorated long-and-short-haul clause, and a commerce court, but it also contained provisions that were undesirable to railroads. Shipper control over routing would encourage non-price competition. The water carrier amendment to the long-and-short-haul provision reduced the incentive for a railroad to cut rates in competition with water carriers. The authority to suspend rates would benefit shippers when charges.were generally on the rise but would benefit railroads

17 when prices were declining, a situation which had prevailed since the Civil War.

Transportation Act of 1920

While the data are not good, Table 2 indicates the basic profitability of the railroads prior to World War I. As can be seen from the table, after the breakdown of regulation in 1893, and with a recession, profits plummeted. Stable price arrangements were reestablished by the end of the century. The Elkins Act was followed by prosperous years as was the Hepburn and Mann-Elkins Acts. Thus, if regulation was intended to increase the profitability of the u.S. railroads, it may have been successful, although improved business conditions may also have accounted for their better fortunes. Nevertheless, while profits did grow, it is apparent that not all the railroads shared in the better situation, for by 1916 almost 10 percent of the miles of tracks operated were in the hands of receivers -the worst situation since 1896. In the years prior to World War I, the public was becoming more concerned with the economic health of the railroads, especially the "weak road/strong road" problem. In 1914, the ICC, in "The 5 Percent Case," explicitly recognized the need for railroads to earn a fair return on their investment, whereas before, neither the commission nor Congress had considered the overall profitability of the railroads. After an initial decline following the start of World War I in 1914, railroad business picked up in 1916. In that year, railroads earned record amounts, although as a rate of return on investment profitability may have been greater in some earlier years.7 Rates started up rapidly in 1917 as inflation gathered steam. Competitive jealousies, some failure to coordinate activities, and a rapid escala­ tion of rates led Congress to take over the railroads on December 28, 1917. President Wilson requested that Congress guarantee to the transportation companies a profit equal to the average of the three preceding years, a period which included two of the three most profitable years of railroad history. At the end of the war there was considerable dispute over the future of the railroads. While some wanted to maintain federal control either indefinitely or for a period of time, others wanted the railroads promptly returned to private hands. Rates, during the period of federal control, had risen 25 percent, but costs had esca­ lated even more rapidly, and by the last year of federal control the government was subsidizing rail carriage by about $1.5 billion.

18 Table 2 PROFITABILITY OF THE RAILROAD INDUSTRY 1890-1917 Miles of Track Operated by Receivers Net Income Thousands Percent of Year ($ millions) of miles U.S. track 1890 106 1891 115 1892 120 1893 (Breakdown of 114 regu lati on) 1894 60 41 17.8 1895 60 38 16.2 1896 95 30 16.7 1897 86 19 7.8 1898 147 13 5.2 1899 177 10 3.9 1900 252 4 1.6 1901 273 2 0.9 1902 315 1 0.5 1903 (Elkins Act) 338 1 0.4 1904 317 1 0.4 1905 365 1 0.3 1906 (Hepburn Act) 434 4 1.2 1907 488 4 1.2 1908 444 10 2.9 1909 441 11 3.1 1910 (Mann-Elkins 583 5 1.5 Act) 1911 547 5 1.3 1912 453 10 2.6 1913 547 16 4.3 1914 395 19 4.8 1915 355 30 7.7 1916 735 35 8.8 191} 658 17 4.3

Source: u.s. Bureau of the Census, Historical Statistics of the United States, Colonial Times to 1957, Series Ql13, Q124, and Q48 (Washington, D.C.: Government Printing Office, 1960).

19 Almost all informed opInIon at the time held that the major problem of the railroad industry was to obtain adequate earnings. For example, Professor Frank H. Dixon, professor of railway eco­ nomics, Princeton University~ writing in Railroad Legislation (Acad­ emy of Political Science Proceedings), said: Among the added powers that should be conferred upon the Federal Commission is the power to prescribe minimum rates. It is vital to the solution of the entire problem of relativity that a railroad corporation should be prevented from demoralizing the rate structure by a policy of rate reductions, which while temporarily bolstering up its own earnings and benefiting its local shippers, is causing the country at large an economic loss by throwing the burden on other traffic and by depriving routes better located of the opportunity of handling the business. Shippers have come to realize, if the general public has not, that specific rates may be too low as well as too high. R Railroad spokesmen were similarly urging that legislation be concerned with maintaining adequate earnings. Alfred B. Thorn, general counsel of the Association of Railroad Executives, wrote that We believe that all revenues must come from rates; that it is as much beyond the limits of constitutional regulation to make the rates too high for the service as it is to make the rates too low; ...9 The result was the Transportation Act of 1920. This act com­ pleted the total cartelization of the railroad industry. While the act was mainly designed to ensure adequate profits, it especially focused on the weak road/strong road problem. Congress was particularly concerned that sufficient profits be provided to ensure the survival of the weak roads but at the same time Congress did not want to furnish the strong roads with "windfall gains." As a result, except for the recapture provision, the Transporta­ tion Act of 1920 could not be a better bill from the point of view of the railroads if they had drafted it themselves. One of the most significant provisions of the act was the rule of rate making, which recognized the need for railroads to make adequate earnings. It provided: In the exercise of its power to prescribe just and reasonable rates the Commission shall initiate, modify, establish or adjust such rates so that the carriers as a whole (or as a whole in each of such rate groups or territories as the

20 Commission may from time to time designate) will, under honest, efficient and economical management and reason­ able expenditures for maintenance of way, structures and equipment, earn an aggregate annual net railway operating income equal, as nearly as may be, to a fair return upon the aggregate value of the railway property of such carriers held for and used in the service of transportation: provided, that the Commission shall have reasonable latitude to modify or adjust any particular rate which it may find to be unjust or unreasonable and to prescribe different rates for different sections of the country.1 0 (Italics in original.)

The designation of a fair rate of return was left to the ICC, but for the first two years Congress specified that 5.5 percent would be a fair rate of return plus 0.5 of 1 percent for improvements and betterments. Since the rule of rate making would result in some railroads earning considerably above a fair rate of return while others would earn less than the fair return, Congress added the "recapture clause." This provision specified that half of the earnings over a fair rate of return, that is, over 6 percent for the first two years, would be paid to the ICC to be placed in a contingency fund. The commission was authorized to make loans from this fund for capital expenditures or to refund maturing obligations. The objective was to utilize part of the profits of strong carriers to aid weak lines. As an incentive to continue to be efficient and to modernize, the railroads were per­ mitted to keep half of any earnings over a fair rate of return. (In actual practice the recapture clause did not work well. Carriers found that earnings exceeded the fair rate of return only sporadically and resisted paying anything to the federal government in the good years on the grounds that the funds were needed to offset bad years. Only a small amount was ever paid to the government. In 1933, in the face of the severe financial pressure resulting from the depression which was sending lines into bank­ ruptcy, Congress repealed the recapture clause retroactively. All obligations of carriers to the government were cancelled with the sums paid into the fund returned to the lines that had earned them.] Another provision of the act which was intended to bring relief to weak carriers directed the commission to consider "the amount of revenue required to pay their respective operating expenses, taxes, and a fair return on their railway property held for and used in the service of transportation" in establishing or regulating the division of

21 joint rates between carriers. Thus, weak lines were to be favored in the division of joint rates. Concern for the financial well-being of the industry was reflected in a new provision authorizing the commission to control minimum rates. Such a provision was necessary to prevent competitive rate cutting and consequently had been requested by the ICC regularly since 1893. Authority to control minimum rates was of course welcomed by the railroads as necessary to preserve rate stability and cartel pricing. This regulatory restraint has been an important element of ICC regulation to this day. Since Congress was no longer concerned with the problem of monopoly pricing, the act of 1920 not only repealed the prohibition on pooling, but also authorized the commission to approve of pools when they would be (1) "in the interest of better service to the public or economy in operation," and (2) "not unduly restrain competition." Since pools always restrain competition, the latter provision was difficult to meet. There were a number of other provisions which strengthened the control of the ICC over carriers. Not only was the commission given authority over minimum rates, it was also given the power to prescribe actual rates whenever the rates were found to be unjust or unduly discriminatory. Control over entry was also granted to the ICC with the stipulation that a certificate of convenience and neces­ sity be secured from the commission for all new construction. The act, however, limited the ICC's discretionary power to grant exemp­ tions to the long-and-short-haul clause. Several provisions were included at the request of the industry to eliminate burdensome state controls on carriers. The act gave to the commission exclusive and plenary control over the issuance of all new securities. Exclusive commission control was strongly desired by carriers since many states had independently been regulating new securities, with the result that conflicting state regulations often hampered their financial operations. For a similar reason, control over abandonments was vested in the ICC. State authorities had used their regulatory power to block abandonments which were opposed by local interests. Another provision authorized the com­ mission to control intrastate rates when such charges discriminated against interstate commerce. In several cases state regulatory author­ ities had required low intrastate rates to facilitate their own manu­ facturing products, which, of course, resulted in a drain on the revenue of railroads; any deficit caused by such a drain had to be made up by higher interstate prices.

22 The commission was also instructed to draw up a consolidation plan designed to combine weak lines with the stronger ones. The commission was given no authority to require railroads to merge, but it could approve mergers which were consistent with its plan. Other provisions of the act included prohibition of interlocking directorates, changes in accounting provisions, and authority for the ICC to require the joint use of terminals. With the added authority went added membership; the act expanded the membership of the commission to 11, a very unwieldy number. The Transportation Act of 1920 established a framework for regulation of railroads that has remained almost intact to this day. A few provisions have been changed: the recapture clause was repealed, and the rule of rate making rewritten. But basically the power of the ICC to control entry, new construction, abandonments, issuance of new securities, minimum rates, maximum rates, and to prescribe specific rates established by the act of 1920 remains intact. Earlier regulatory acts with some exceptions were ambiguous in their aim. Some of the provisions were designed to prevent monopoly pricing, others to reinforce cartel activity. The act of 1920 was aimed at producing higher profits in the industry by, in effect, com­ pletely cartelizing the railroad industry. The only element missing in providing for a legal cartel was an exemption from the antitrust laws for rate collusion. This was added by the Reed-Bulwinkle Act of 1948.

The Depression and the Railroads

As has been stressed above, the intent of the 1920 act was to increase the profitability of the railroads, but the railroads as a whole never did achieve the average legal fair return of 6 percent, although some lines did earn that much or more in particular years. During the 1920s, carrier earnings continued to grow, along with ton-miles hauled. At the same time, however, a budding competitor was developing-the trucking industry. With the onslaught of the depression, earnings plummeted along with ton-miles hauled. In 1931, in the face of increased competition from trucking and a decline in demand, the ICC authorized the rail­ roads to increase rates, with the result that the rail carriers lost more money in 1932 than ever before or since. In fact, only twice since 1890 has the net income of the railroad industry as a whole been negative, once in 1932 and once in 1938. With mounting railroad bankruptcies, Congress acted by passing the Emergency Transportation Act of 1933. This act, as mentioned earlier, repealed the recapture clause. It also provided for a new rule of rate making. This rule said: In the exercise of its power to prescribe just and reasonable rates the Commission shall give due consideration, among other factors, to the effect of rates on the movement of traffic; to the need, and the public interest, of adequate­ and efficient railway transportation service at the lowest cost consistent with the furnishing of such service; and to the need of revenues sufficient to enable the carriers, under honest, economical, and efficient management to provide such service.!! This new rule of rate making was more general and simpler than the earlier provision. While somewhat greater discretion in approv­ ing rates is given the commission, the revenue needs of carriers continue to be recognized as an important consideration in rate making. The act also established an Office of Federal Coordinator of Transportation with a federal coordinator to be appointed by the President from among the membership of the ICC. The objectives of establishing this office were to increase efficiency in transportation by coordinating the railroads and to investigate methods for improv­ ing transportation conditions in the country. The first objective, to bring efficiencies by coordinating railroad activities, was in large part unsuccessful. While the federal coordinator suggested a number of steps, the independent executives of the lines continued to operate much as they had in the past. The federal coordinator, however, did suggest that transporta­ tion conditions in the country could be improved if motor carriers and water carriers were brought under ICC control. This recom­ mendation, together with other factors, led directly to the control of trucking in 1935 and to the control of water carriers through the Transportation Act of 1940. Both of these regulatory steps are discussed below.

24 CHAPTER III

THE DEVELOPMENT OF MULTI-MODAL REGULATION

Prior to 1935, federal regulation of transportation was confined solely to railroads and oil pipelines. Both industries ostensibly have some of the characteristics of natural monopolies, and both are heavily capital intensive, with the result that short-run variable costs may be well below long-run levels. The utility model of regulation adapted to railroads does not appear to be obviously misdirected, but with the extension of regulation to additional modes of transporta­ tion, both the theory and the practice of regulation had to be stretched to fit a new environment.

Motor Carrier Regulation

Before 1935, all regulation of truck transportation in the United States, such as it was, was under state law. In 1928, for example, 43 of the 48 states were regulating passenger motor carriage and 33 of the 48 states were regulating freight transportation. Four years later, in 1932, the number regulating passenger transportation had risen to 47 with 39 states controlling the motor carriage of freight. Regulation by states was not very effective, however, since a 1925 Supreme Court ruling held that interstate traffic was not subject to state jurisdiction. With the 1925 Supreme Court ruling came pressure for federal regulation of motor carriers. The first bill to authorize such regula­ tion-the Cummins Bill-was introduced in Congress that same year but did not pass. In each succeeding year until 1935 new legislation was introduced in Congress to regulate motor vehicles with some 37 unsuccessful bills proposed altogether.

25 The main pressure for regulation of motor carriers came from the ICC and rail carriers, which conducted extensive public relations campaigns and lobbying efforts to that end. Lined tip against regula­ tion were shippers, most freight motor carriers, and vehicle manu­ facturers. Until 1933, this lineup for and against regulation remained virtually intact.! As the reader will recall, the federal coordinator of transporta­ tion, established by the Emergency Railroad Transportation Act of 1933, proposed the regulation of motor carriage in 1934. Federal Coordinator Joseph B. Eastman, an ICC member, pointed to the bitter competition within the trucking industry and between the motor carriers and rail carriers. With excess capacity ubiquitous­ due to the depression-and with vast numbers of unemployed, almost any occupation that would produce a little net income "vas swamped. With entry into trucking extremely easy, many unemployed pur­ chased second-hand vehicles and scrambled for the limited business. With trucking earnings and trucking rates depressed by this vigorous competition, railroad profits suffered. Mr. Eastman concluded that many rail lines were being forced into bankruptcy due to the "cutthroat" competition in the trucking industry. By 1935, the groups favoring regulation of trucking included, naturally, the railroads and the ICC, a number of large truckers, some motor bus operators, and a few shippers. Those opposing regulation of trucking included the National Industrial Traffic League, the National Highway Users Conference, the American Trucking Asso­ ciations, the Automobile Manufacturers Association, the National Association of Motor Bus Operators, and many farm organizations. One other factor played a role in the regulation of motor carriage. In the heart of the depression, Congress and the American people temporarily lost faith in competition and free enterprise. Attempts were made by the government to cartelize most industries through the National Industrial Recovery Act. Agriculture and coal were both brought under federal control with separate acts. Thus, the proposal. for- regulating trucking by the federal coordinator fell on fertile ground, and Congress enacted the Motor Carrier Act of 1935. The provisions of this act, which with a few exceptions have remained virtually unchanged to the present day, deal ,vith the three areas most important to regulation: entry, rates, and service. The act essentially divides the industry, for the purpose of regulation, into three sub-industries: common carriers, contract carriers, and the exempt industry. The latter is not subject to economic regulation, but, like the rest of the industry, is subject to safety regulation.

26 Exempt Carriage. Included in the area of trucking not subject to regulation are private carriers hauling their owners' goods; motor vehicles owned by railroads, water carriers, or freight forwarders incidental to their own business; local carriage; motor vehicles carrying fish, livestock or agricultural commodities (not including any products manufactured thereof); trucks carrying newspapers exclusively; and trucks owned and operated by agricultural coopera­ tives when carrying goods to and from the cooperatives for farmers. No more than half the transportation business of an agricultural cooperative can be carried on for nonmembers. These exempt areas of trucking normally carryover 60 percent of the ton-miles of freight moved by trucking in interstate commerce. Common Carriers. A common carrier can be defined as a firm that holds itself out to carryall persons or the goods of all persons indif­ ferently. This does not mean that a common carrier will carryall types of goods or carry anyone type between all points. The definition means that the same type of commodities will be moved for all shippers between the same points. Under the Motor Carrier Act all common carriers (not subject to the above exemptions) must have certificates of convenience and necessity issued by the commission. The law requires that the certificate specify the service to be rendered and the routes over which, the fixed termini, if any, between which, and the intermediate and off-route points, if any, at which, and in case of operatives not over specified routes or between fixed termini, the territory within which, the motor carrier is authorized to operate....2 The act also includes a "grandfather clause" directing the commis­ sion to issue a certificate of convenience and necessity to those who were in bona fide operation as a common carrier on June 1, 1935. In acting on the 89,000 applications by common and contract carriers under the grandfather clause, the ICC carried out the con­ gressional mandate to grant certificates by limiting them to the areas actually served and the commodities actually carried. Thus, even if a trucker had held himself out to carry goods over a wide area but in fact had only moved them over a much smaller area, the certificate would limit his future operation to the smaller area. The issuance of a certificate to those not coming under the grandfather clause requires the commission to find that the applicant is fit, willing, and able properly to per­ form the service proposed ... and that the proposed service

27 · .. is or will be required by the present or future public convenience and necessity....:{ These conditions require the commission to investigate whether the applicant is a suitable firm to operate as a common carrier. Pre­ sumably by filing an application a firm indicates its \villingness to perform the service. A showing of the requisite equipment and man­ power would satisfy the able requirement. In deciding on whether the proposed service is required by public convenience and necessity, the commission must consider the need for the service, the advan­ tages to shippers if the certificate is granted, and the possible loss to other carriers from any loss in business resulting from the new carrier. The certificates also specify the commodities or classes of commodities a carrier may move. While many certificates are for general commodities, others narrowly circumscribe the commodities that the firm may handle. In 1944, a study conducted by the Board of Investigation and Research indicated that 62 percent of the truckers were limited to special commodities with 40 percent of those limited restricted to one commodity or commodity class. Eighty percent had been restricted to six or less.-! While such limitations obviously impose major costs on common carrier trucking firms by increasing the difficulty of filling backhauls, they also reduce com­ petition within the motor carrier industry. Motor common carriers are divided by the ICC into two cate­ gories: regular route carriers and irregular route carriers. Regular route carriers are authorized to carry their goods only over specific routes and to and from indicated points. Irregular route carriers are authorized to carry defined commodities or groups of commodi­ ties within a designated territory, picking up and delivering to named points. Sometimes authority is given to operate generally within a particular region. However, the ICC has attempted to maintain a clear distinction between regular route carriers which are expected to offer frequent and regular service over named routes between specific points, and radial carriers which are barred froDl offering too frequent service between any points. Clearly, these restrictions are costly. They result in trucking firms passing up profitable business and refusing traffic to unauthor­ ized areas. Sometimes these restrictions force shippers to deal with several trucking firms since no one carrier is authorized to serve their entire needs. The 1944 study referred to above revealed that about 70 percent of the regular route common carriers possessed less than full author­ ity to serve intermediate points on their routes. Approximately 10 percent had no authority to serve any intermediate point. It also

28 disclosed that many irregular route carriers had to operate through points that they could not legally serve, and regular route common carriers often had to follow circuitous routes and specific highways. About a third of the intercity truckers had return limitations, with almost 10 percent having no authority to transport traffic on their return trip. While these percentages may be out of date, the ICC admitted in 1955 that the situation was much the same then as earlier. There is no reason to believe that the restrictions have become less onerous in recent years. The Doyle Report in 1961 said "we have found no evidence to controvert the findings of the [Board] or to indicate any material reduction of or change in the nature of the problenl as it existed at that time.":-· The provisions dealing with rate regulation are virtually identical for motor common carriers and for railroads. The Motor Carrier Act of 1935 requires that all rates and fares be reasonable and not unjustly discriminatory. The commission may suspend a rate for up to seven months, prescribe the maximum rate, the minimum rate, or the actual rate to be charged. In actual practice the commission has been more concerned with the specification of minimum rates than with maximum rates. The 1948 Reed-Bulwinkle Amendment to the act authorized the commission to exempt from the antitrust laws any rate agreements proposed or made between carriers. The Motor Carrier Act of 1935 also required that all rates be published and adhered to with thirty-days notice provided for any change. Together with the Reed-Bulwinkle Act, this provision sig­ nificantly discourages independent pricing. Section 204(a)(1) of the Interstate Commerce Act prescribes the duty of the commission: To regulate common carriers by motor vehicles ... [T]he Commission may establish reasonable requirements with respect to continuous and adequate service....G Other sections of the act specify the obligation of carriers to provide "safe and adequate service." Together these sections provide the commission with almost unlimited authority over service. Never­ theless, as will be discussed below, the commission has had difficulty guaranteeing service for small shipments to out-of-the-way places and for the movement of household goods.

Contract Carriers. Contract carriage in principle is a semi-private service provided by integrating the trucking operation into the day­ to-day activity of a shipper. Thus, it is only slightly removed from shipper-owned carriage and is conceptually distinct from common

29 carriage. The latter service in theory is offered to all shippers at least offering the same type of goods between the same points. In practice, however, the distinction between the two types of service is not always obvious. The commission has held that there were two distinguishing characteristics of contract carriers as opposed to common carriers: contract carriers offer a specialized service for particular shippers, and contract carriers tend to deal with only a few shippers. In a 1954 case, the commission held that a carrier which increased the number of contracts from 13 to 69 was operating as a common carrier without authorization. The Supreme Court, two years later, held that the commission had erred and that a contract carrier is free to solicit business aggressively. A 1957 amendment to the Motor Carrier Act closed this loophole by specifying that a contract carrier must be under continuing contracts with one person or a limited number of persons either (a) for the furnishing of trans­ portation services through the assignment of motor vehicles for a continuing period of time to the exclusive use of each person served or (b) for the furnishing of transportation services designed to meet the distinct needs of each individual customer.7 The 1935 act specified that only a contract carrier's mInImum rates must be publicized. Upon complaint of common carriers and railroads, Congress in 1957 required contract carriers to publish actual rates and to adhere to them. Clearly this diminished the competition between contract carriers and other types of carriers. Ostensibly, the rules governing entry differ between contract carriage and common carriage. While the operation as a common carrier requires a certificate of convenience and necessity, a contract carrier is simply required to have a permit. The law reads that a permit shall be issued to any qualified applicant ... if it appears from the application or from any hearing held thereon, that the applicant is fit, willing, and able properly to perform the service of a contract carrier by motor vehicle ... and that the proposed operation ... will be consistent with the public interest and the national transportation policy declared in this Act. ... In determining whether the issuance of a permit will be consistent with the public interest and the national transportation policy ... the Com­ mission shall consider the number of shippers to be served by the applicant, the nature of the service proposed, the effect which granting the permit would have upon the

30 services of the protesting carriers and the effect which denying the permit would have upon the applicant and/or its shipper and the changing character of that shipper's requirements.8 While Congress presumably intended a certificate to differ from a permit, both types of carriers must be fit, willing, and able. In evaluating the public convenience and necessity the commission must consider the same factors as it is directed to consider in evaluating the public interest and the national transportation policy. As will be seen below in a discussion of commission policies, it seems, in practice, to be equally difficult to secure a certificate or a permit.

Water Carrier Regulation

While the ICC had jurisdiction over joint rates for water and rail, it wasn't until 1940 that the commission was authorized to control other aspects of inland water carriers. As might be suspected, the chief advocate of bringing inland water carriers under federal regulation was the railroad industry, which had been suffering from the competition of inexpensive water carriage. The 1934 report of the federal coordinator recommended that the water carriers as well as motor carriers be brought under regulation. The resulting 1940 statute parallels the Motor Carrier Act. Common carrier operation requires certificates of convenience and necessity. Contract carriers must hold permits. For common carriers, the commission can prescribe minimum, maximum and actual rates. All such rates must be published, adhered to, and free from unjust discrimination. Thirty days notice must be given before rate changes. A significant difference between the regulation of water carriers and that of truck and rail is that all bulk water carriers are exempt from regulation, provided not more than three bulk commodities are carried in the same vessel or tow. Bulk commodities are defined to be products transported in bulk in accordance with existing custom, which when loaded are carried without wrappers or containers and which are received and delivered by the carrier without transporta­ tion mark or count. Liquid cargoes are likewise exempt from regula­ tion. In addition, Congress exempted commodities transported by contract carriers "which, by reason of the inherent nature of the commodity transported, their requirement of special equipment or their shipment in bulk, is not actually and substantially competitive with" any motor common carrier or railroad.9 Small craft of not more than 100 tons or more than 100 horsepower and the movement

31 within harbors is also unregulated, unless the commission declares regulation necessary to carry out the national transportation policy. These exemptions, together with the exemption for private carriage, result in 90 percent of the total intercity ton-miles by ,vater carriers not being under ICC control. Contract carriers by water and by truck are subject in the main to the same basic regulation of rates. The commission Inay prescribe the minimum rates for such carriers but not maximum rates. The published minimum rates cannot be undercut and the contract car­ riers must give thirty-days notice before any such rates are lowered. Nevertheless, actual rates need not be filed with the commission by water contract carriers, whereas motor contract carriers must do so. Like trucking firms, water carriers are exempt from the anti­ trust laws under the Reed-Bulwinkle Act. Even though collusion is not only feasible but actually exploited to raise profits--such a small proportion of the tonnage moving by water carriers is subject to regulation-its effect is small compared to other modes. While the requirements to become a common carrier by water appear to be the same as by motor, the requirements to enter as a contract carrier appear to be easier. Congress prescribed the identi­ cal entry conditions for common carriers under the t\\;O sections of the act dealing with water carriage and motor carriage, but the paragraphs concerning contract carriage differ in that for motor carriage five tests are listed to determine whether a contract is consistent with the public interest and the national transportation policy. No such tests are required for water contract carriage per­ mits, although the commission could infer their existence. Thus, at least superficially, it appears that Congress has mandated a somewhat easier entry requirement into contract carriage by water than by truck. I

Freight Forwarder Regulation

Freight forwarders are firms or individuals who combine small ship­ ments into larger truckload or carload lots. Basically, a freight forwarder operates on the margin between carload or truckload rates and less-than-carload or less-than-truckload rates. A freight for­ warder normally will hold himself out to handle a shipment from origin to destination. In most cases, the freight forwarding firm will have its own vehicles for pickup and delivery, but it will use common carriers for moving the goods between the major breakbulk points. As early as 1930, the ICC was recommending to <:ongress that freight forwarders be brought under regulation. Between 1937 and

32 1938 the commission investigated the role freight forwarders played in transportation and their dealings with railroads.10 The commis­ sion found that railroads were systematically price cutting to freight forwarders and offering them superior services. Many railroads, the ICC found, offered freight forwarders facilities at their depots at little or no rent. In a few cases new facilities were built for the freight forwarder, and in at least one case such a facility was provided the freight forwarder without charge. Railroads had furnished freight forwarders with extra cars and freight cars were loaded and unloaded at less than cost or free. "All commodity" rates were often charged on cargoes which were made up substantially of a particular class that should have carried a higher rate. Moreover, the railroads were found to have, in many casas, expedited services for freight forwarders. Finally, the rail lines were found to have extended forwarders credit for longer than was permitted by ICC regulation. These preferences shown freight forwarders by rail carriers stemmed from the ability of the freight forwarders to attract a considerable amount of less-than-carload shipments and combine them into economical loads while permitting the carriers to con­ centrate on their more efficient operation of wholesaling long-haul bulk transportation. Thus, the freight forwarders were providing a major service to the railroads as well as to shippers. But the ICC viewed these arrangements as threatening the stability of the rate structure and as permitting more competition between railroads. The reaction of the ICC was to wish that freight forwarders would disappear. In its report on the investigation, the commission said: This record reveals no persuasive reason why the rail lines could not, by appropriate cooperative effort, afford an effi­ cient service on less-than-carload forwarder traffic, includ­ ing collection and delivery thereof, either by themselves or through one or more wholly owned and controlled agencies, at less-than-carload rates specially designed to attract such traffic, and thus retain for themselves the entire profit from such service.11 This paragraph reflected the view of the ICC that freight forwarders were unnecessary, but more importantly, it also reflects a continuing belief by the commission that there are large economies to be achieved by integration and coordination of the railroads. Thus, if the rail operators cannot successfully perform freight forwarding serv­ ices individually, the ICC would recommend combining the lines

33 until they could perform satisfactorily as freight forwarders. In the same report the commission goes on to say: We further find that, should the rail lines, by appropriate cooperative effort, fail to perform a less-than-carload serv­ ice, including collection and delivery of freight, either by themselves or through one or more wholly owned and con­ trolled agencies, whereby traffic which is now being handled by the forwarder, together with the present less-than­ carload traffic, will be handled under a basis of graduated quantity rates adjusted in such manner that the less-than­ carload shipper can ship in his own name and be treated the same as any other shipper in less-than-carload lots, then and in that event the only effective means of correcting many of the abuses practiced by forwarders as portrayed upon this record and illustrated in this report is by the enactment of legislation regulating the forwarder so as to prohibit unreasonable, unjustly discriminatory, and unduly prejudicial and preferential rates, charges, rules, and prac­ tices, and regulating specifically the relations between the forwarder and other transportation companies.12 The commission noted that freight forwarders would welcome appropriate legislation for their regulation and urged Congress to bring them promptly under ICC jurisdiction. In 1940 Congress took up the subject of freight forwarders, but there was considerable railroad opposition to their regulation, with the result that the Con­ gress put off a decision for two years. Not until 1942 did Congress bring regulation to freight for­ warders and then with some interesting differences from other regulation. Entry required not a certificate of conyenience and necessity, but a permit. Such a permit was to be issued whenever the commission found that the applicant is ready, able, and willing properly to perform the service proposed, and that the proposed service to the extent authorized by the permit, is or would be consistent with the public interest and the national transportation policy.13 While these words are almost identical to the paragraphs specifying the granting of a permit for contract carriers by motor and by water, Congress added an additional paragraph, which read: The Commission shall not deny authority to engage in the whole or any part of the proposed service covered by any

34 application made under this section on the ground that such service will be in competition with the service subject to this part performed by any other freight forwarder or freight forwarders.14 Thus, the competitive impact of a new firm was not to be used to deny entry. This paragraph was added mainly at the request of the railroads, since, while some railroads owned freight forwarding sub­ sidiaries, others did not. The ones not in the freight forwarding business wanted to be in a position in the future to initiate such companies if, in their opinion, it was economical to do so. In 1957, at the request of the commission and freight forwarders, Congress rephrased the above quoted paragraph so that the railroads are now the only entities which may take advantage of this exemp­ tion from the competitive impact test.15 All other potential entrants must meet the standard tests of entry into any regulated transporta­ tion field. The act exempts from regulation freight forwarding performed by or under the direction of a cooperative association as defined in the Agricultural Marketing Act. It exempts freight forwarding where the property shipped is ordinary livestock, fish, agricultural com­ modities, or used household goods. However, in recent years the exemption dealing with used household goods has been eroded to the point where most freight forwarders dealing in used household goods have sought and received permits from the commission. Rate regulation of freight forwarders is similar to that for common carriers of other modes: rates must be reasonable, non­ discriminatory, published and adhered to; thirty-days notice must be given before a rate is changed; and the commission is authorized to determine maximum, minimum, or actual rates. In addition, the act permits freight forwarders to enter into contracts with motor carriers to establish rates for freight forwarder truckload shipments. These contracts must be just, reasonable, and equitable, and cannot unduly prefer or prejudice any of the participants or any other freight forwarder. Moreover, the rates cannot be lower for any shipment of more than 450 highway miles than that established for all ship­ pers. Thus, freight forwarders are authorized to secure contracts for lower rates than most shippers are permitted provided the ship­ ment is for less than 450 miles. All such contracts must be filed with the comn1ission, which is authorized to change, amend, and prescribe the conditions of any contract found to be inconsistent with the act.

35 Intermodal Regulation

The railroads continued to suffer from weak earnings throughout the 1930s, and the 1938 decline in business led to the second period of overall industry losses for rail carriers. To recommend steps to bring the carriers into the black, President Roosevelt established two committees, one consisting of three members of the ICC and the second consisting of six railroad, management and labor representa­ tives. In 1940 both these committees made recommendations for changes in regulation and in the federal law. As a result a com­ promise bill-the Transportation Act of 1940-which, among other things, provided for the regulation of water carriers, was enacted. In order to guide the ICC in regulating three separate industries­ railroads, motor carriers, and water carriers-a declaration of na­ tional transportation policy was included in that act. This declara­ tion, which still serves as a guide to the commission in determining policy, reads: It is hereby declared to be the national transportation policy of the Congress to provide for fair and impartial regulation of all modes of transportation subject to the provisions of this Act, so administered as to recognize and preserve the inherent advantages of each; to promote safe, adequate, economical, and efficient service and foster sound economic conditions in transportation and among the several carriers; to encourage the establishment and maintenance of reason­ able charges for transportation services, without unjust discriminations, undue preferences or advantages, or unfair or destructive competitive practices; to cooperate with the several States and the duly authorized officials thereof; and to encourage fair wages and equitable working conditions; all to the end of developing, coordinating, and preserving a national transportation system by water, highway, and rail, as well as other means, adequate to meet the needs of the commerce of the United States, of the Postal Service, and of the national defense. All of the provisions of this Act shall be administered and enforced with a view to carrying out the above declaration of policy.lG This policy statement is ambiguous but would appear to direct the ICC to allow the lowest cost mode of transportation in each case to secure the traffic. However, the commission has interpreted the words "preserve the inherent advantages of each" to imply that no carrier should be permitted to undercut carriers of another mode if

36 the latter carriers have a lower "fully allocated cost" even if the proposed rate covers the cost of the carrier filing the new charge.17 The commission has also taken seriously the mandate to prevent "unfair or destructivt~ competitive practices." The net result is that the commission has been reluctant to approve of new rates which would upset the competitive balance even when they cover all the costs. Because Congress feared that the commission would interpret the rule of rate making and the national transportation policy to protect one mode of transportation from the competition of another, the Transportation Act of 1940 also amended the rule of rate making to read in part (new material is italicized): In the exercise of its power to prescribe just and reasonable rates the Commission shall give due consideration, among other factors, to the effect of rates on the movement of traffic by the carrier or carriers for which the rates are prescribed. ...]8 This amendment and the statement of national transportation were Congress' first attempts to restrict the ICC from protecting one mode from the competitive inroads of another-"umbrella rate making." 19 In the same act, however, Congress imposed on carriers the burden of proof for lowering rates as well as raising rates, which made intermodal competition as well as intramodal more difficult.

Reed-Bulwinkle Act

The Reed-Bulwinkle Act of 1948, which has been referred to earlier, was the next major legislation on transportation. Railroads had utilized rate bureaus for decades, first to agree on through and inter­ change traffic and later to agree on charges for competitive traffic. In 1945 the Supreme Court reaffirmed, in a suit brought by the State of Georgia against the Pennsylvania Railroad, that regulated indus­ tries were not exempt from the antitrust laws.20 Congress promptly enacted the Reed-Bulwinkle amendment to the Interstate Commerce Act. This act grants immunity from the antitrust laws to carriers that organize rate bureaus to establish rates providing the rates proposed and methods used by the rate bureaus are approved by the ICC. The Reed-Bulwinkle Act specifically guarantees each carrier the right to take any independent action it wishes irrespective of a rate bu­ reau's policy. However, considerable informal pressure can no doubt be brought to bear to ensure conformity. The act also bars intermodal

37 rate bureaus or agreements except those dealing with joint or through rates.

Transportation Act of 1958

After the Second World War, railroad passenger transportation quickly diminished, while railroad freight declined relatively as trucks took an increasing proportion of the business. The result was continued hard times for rail carriers. In 1954, President Eisenhower asked Secretary of Commerce Sinclair Weeks to head up an advisory committee on transportation policy and organization. The cabinet level committee's report rec­ ommended a relaxation of regulation which included setting the mini­ mum rate floor for both intra- and intermodal cases at the level of the direct ascertainable cost of carrying the product. In other words, the Weeks committee was advocating that marginal cost or out-of­ pocket costs be used as the guide for determining when a proposed rate was not compensatory, and hence too low, instead of fully allocated costs often used by the ICC. The committee also recom­ mended that the ICC's power to prescribe actual rates be abolished and that the rule of rate making be rephrased. None of these recom­ mendations were followed, although future studies and future rec­ ommendations have drawn on some of the ideas presented in the Weeks report. In the Transportation Act of 1958 Congress did attempt to limit umbrella rate making. With the railroads still weak in the late 1950s, Congress enacted the Transportation Act of 1958, the aim of which was partly to guarantee loans to the rail companies and partly to anlend the rule of rate making by adding to the Interstate Commerce Act this addi­ tional paragraph designed to promote more intermodal competition: In a proceeding involving competition between carriers of different modes of transportation ... the Commission, in determining whether a rate is lower than a reasonable minimum rate, shall consider the facts and cirCUlnstances attending the movement of the traffic by the carrier or carriers to which the rate is applicable. Rates of a carrier shall not be held up to a particular level to protect the traffic of any other mode of transportation, giving due consideration to the objectives of the national transportation policy....21 Since the ICC has operated as though the national transportation policy directed it to protect each mode of transportation, the last

38 clause of this new paragraph led to some ambiguities as to the objective of Congress. While the legislative history and most of the words of this paragraph indicate that Congress did not want the commission to protect one mode from competition of another mode, in actual practice the ICC has ignored this paragraph and continued to evaluate the impact of a lower rate of one carrier on the business of another mode. Although Presidents Kennedy, Johnson, and Nixon have all recommended major changes in regulatory practices and legislation, Congress has not seen fit to make any significant additional changes. Each administration recommended more reliance on competition and less regulation, although the details of the proposals differed.

39

CHAPTER IV

REGULATORY PRACTICES

Regulatory practices of the ICC tend to be remarkably similar across modes as do the statutory provisions. Entry requirements, rate determinations, and service policies follow the same format for each sector. However, each mode has its own particular twists. For example, the control of entry is no problem in the railroad industry, while motor carrier abandonments are unregulated. This section will consider the major regulatory areas individually-entry, rates, serv­ ice, and mergers-and indicate how the ICC deals with each.

Entry

A shrinking railroad industry has not encouraged entry and since the 1920s the ICC has had no applicants for new certificates of public convenience and necessity. Applications for entry into other trans­ portation modes have been plentiful, though, and have caused much litigation. The basic rule set down in 1935 for motor carriers and extended to other types of regulated transport reads: Whether the new operation or service will serve a useful public purpose, responsive to a public demand or need; whether this purpose can and will be served as well by existing lines or carriers; and whether it can be served by applicant with the new operation or service proposed with­ out endangering or impairing the operations of existing carriers contrary to the public interest.! Fundamentally, the rule amounts to showing a need for the proposed service that the existing carriers cannot or have been unwilling to

41 nleet. If existing carriers are willing to offer the desired service, then denial of the application is called for. The ICC has put it this way: In the absence of a showing with specificity that the serv­ ices of existing carriers have been tested, and that such carriers have been found to be unable or unwilling to meet the shipping public's reasonable transportation needs within their respective authorized territories, such carriers are entitled, at least, to an opportunity to meet such needs before we can find a need for a new competitive operation.2 In another recent case the ICC said: It has consistently been held that existing carriers should be afforded the opportunity to transport all the traffic which they can handle adequately, economically, and efficiently in the territory they serve before a new service is authorized.3 Prior to showing need, the applicant must show that he is fit, willing, and able to provide the required service. Presumably, his application indicates that he is willing, and \Ivhether he is fit hangs on whether he has violated any ICC regulations or broken other laws. While no recent cases have dealt with whether an applicant is able, it is apparent from a reading of cases that a showing of being able requires that, or at least is easier if, the applicant is already in the trucking business. For example, a review of all cases appearing in the ICC Report, Motor Carrier Cases for a twenty-month period indicate that all de novo applications for entry either as a contract carrier or as a common carrier came from firms which were already in the trucking business. Most applicants had operated on an intrastate basis and wished to expand into interstate commerce. In some cases they held temporary certificates from the ICC, while in a few situations con­ tract carriers were applying for certificates of public convenience and necessity as common carriers. The fact that there were no cases of pure de novo entry is not surprising. It takes months, in some cases years, for a case to be determined under commission procedures, and to show that an applicant is able, the would-be carrier must have access to a sufficient number of trucks and to a sufficient number of experienced drivers with some shippers ready to utilize the pro­ posed service. All of this would be very expensive and difficult for a truly new entrant to show. Annually, the number of applications for permanent operating authority as motor carriers, water carriers, or freight forwarders is huge. For example, in fiscal year 1970 the ICC reported there were 5,058 applications, and in the next fiscal year, there were 5,372.4

42 The commission has not seen fit to report on the proportion of such applications that are approved and the proportion that are disap­ proved. However, if an application is contested, and if it is worth­ while for the applicant to appeal, the case is taken to the commission and the decision printed in the Motor Carrier Cases volumes. This author examined such cases for the three-year period between September 1967 and August 1970. During that period there were 227 cases dealing with entry for common carriers and thirty concerning permits for contract carriers.5 In 1969 there were only 315 contract carriers holding class A or class B certificates, while there were 2,461 common carriers of class I and class 11.(; On an annual basis, the number of cases dealing with applications for certificates of convenience and necessity per 100 firms holding ICC certificates was 3.1, while the number of permit cases per 100 contract carriers was 3.2. Table 3 summarizes the cases found in the ICC reports dealing with entry in motor carriage, water carriage, and freight forwarding. As can be seen, the proportion of cases on an annual basis per 100 ICC licensed firms is roughly the same for all types of carriers; although the rate for water carriers appears lower, the difference is not statistically significant. The rate of approval of applicants like­ wise appears to be quite similar among the different classes of carriers, but with the approval rate being somewhat higher for motor common carriage than for motor contract carriage or water car­ riers, a fact which belies the impression the wording of the Interstate Commerce Act gives that entry requirements are easier for contract carriage than common carriage. As can be seen, about 70 percent of the applicants for entry into common carriage were approved, whereas only 50 percent of the applications for contract carriage were approved. The difference between the two proportions is significant at the 10 percent level but not at 5 percent. Table 4 presents an analysis of entry into the trucking industry. It indicates that the proportion of denial was slightly higher for de novo requests into common carriage than it was for extensions of authority. Extensions of authority, however, clearly dominate the number of applications. It might be generally concluded from a reading of these cases that true de novo entry into trucking is extremely rare-perhaps nonexistent. Even those cases which are classified de novo relate to applications to extend the firm's opera­ tions. Since the number of contract carriage requests was much smaller, no statement is possible about differences between them and common carrier cases.

43 ~ ~

Table 3 ENTRY INTO REGULATED FREIGHT FORWARDING AND MOTOR AND WATER CARRIAGE (January 1965-December 1970)

Rate of Entry Applications Number Number Attempted Completely Approved by ICC of of Formal Entry Licensed ICC (per year per 100 % of total Type of Carrier Carriers Entry Cases in industry) Number applications

Motor carriers (Class I & II)

Common carriers 2461 227 a 3.1 158 70 Contract carriers 315 30 a 3.2 15 50

Freight forwarders (Class A) 65 14 b 3.6 11 79

Water carriers (Class A & B) 90 12 b 2.2 6 50

a Three years from September 1967 to August 1970. b Six years from January 1965 to December 1970. Note: The numbers represent ICC cases reported on, which in some situations represent many different applications. Source: Interstate Commerce Commission Reports, vols. 104-111 (Motor Carrier Cases) and 323-337. Table 4 FORMAL MOTOR CARRIER ICC CASES DEALING WITH ENTRY (September 1967-August 1970)

Common Carriers Contract Carriers

De novo Extension De novo Extension

Approved 30 128 11 4 Denied 11 42 6 8 Denied because Unfit 3 6 2 2 No showing that existing service inadequate 6 30 3 4 Other 2 6 1 2 Mixed 2 13 1

Source: Interstate Commerce Commission Reports, Motor Carrier Cases, vals. 105-111.

Table 4 also presents an analysis of the reasons for denial. The major reason for denial, both for de nove, and extension applications, was that there was no showing that the existing service was inade­ quate. In many proceedings the commission concluded that the existing service was adequate, and in some cases the ICC found there was not sufficient evidence presented to indicate that the existing service was inadequate. For de novo applications, however, the ruling that the applicant was unfit was relatively common. That the unfit category was used to rule out a higher proportion of de novo entrants than extensions is logical since if the applicant is unfit to extend the service it is unlikely that the carrier is fit to ,continue the existing service. A reading of these cases indicates that the ICC is satisfied as long as there is at least one carrier servicing a shipper. The desire by a shipper for a second, third, or more carriers is not evidence that new authorizations should be granted. In many cases, a showing by other carriers that together they would be able to fully service the shipper to all the particular points was sufficient to indicate that there was no need for the proposed service, even when the proposed service would provide the shipper with a single firm that could handle all his needs. While there were no reports that indicated the commission denied applications solely on the basis of impact on the earnings

45 of competing carriers, it clearly was an important factor. In one proceeding in which the commission did approve an application, it did so only on a two-to-one vote overruling the review board, which had approved only certain portions of the application. In this petition the applicant requested authority to use alternative routes that would shorten its travel distance between Philadelphia and the following New York points: Olean, 240 miles; Jamestown, 184 miles; Buffalo, 126 miles; Rochester, 104 miles; Syracuse, 95 miles; and Utica, 35 miles. The majority ruled in favor of the application because "we are not convinced that any new faster service is contemplated." 7 And since no faster service was contemplated, the new authority would not change the competitive structure of the industry or make inroads into the other carriers' business. In the case of an extension request by Michigan Express, Inc., the ICC held that a proposed alternative route which would have reduced circuity by an average of over 20 percent would "constitute a new service which would work a detriment to existing carriers" and thus should be denied.s The ICC considers the maintenance of these restrictions impor­ tant to maintaining the stability of its regulatory procedures and of the industry it regulates. In a 1970 decision the comnlission found a rule permitting "for-hire motor carriers of hazardous materials to utilize the nearest, direct route in the movement of such materials ... in lieu of circuitous routes ... not justified." n One of the major reasons for denying this proposal-which had been supported on safety grounds by the Department of Transportation and the Depart­ ment of Defense, as well as by several motor carriers-was that "one fundamental purpose underlying the economic regulation of motor carriers is to protect the public from the adverse effects of ruinous competition among carriers. ... Existing competitive relationships might be seriously undermined by the adoption of the proposed rule." 10 In other words, the commission put the prevention of com­ petition above the protection of the public from hazardous materials. Besides restricting routing to limit competition the commission has narrowly defined the commodities carriers are authorized to carry. To take a recent (1970) example, the commission found that a trucking firm, Pre-Fab, whose certificate authorized it to carry "prefabricated buildings, complete, knocked-down, or in sections, and when transported .in connection with the transportation of such buildings, component parts thereof and equipment and materials incidental to the erection and completion of such buildings," 1 t could 1 not carry single unit mobile homes. :! The ICC argued that the word

46 "complete" was modified by the words "knocked-down or in sec­ tions." In the same case the commission reported that: Instances of Commission interpretations which exclude from commodity descriptions articles which by literal or academic definition might well have been otherwise in­ cluded are numerous. For example, it has been held that carburetors, distributors, generators, electric motors, and similar commodities are not embraced in the description 'machinery'; that electric regulators are not 'machinery'; that the term 'building material' relates to materials in­ tended to be used for the erection and repair of buildings and not for building operations generally, and that, as a consequence, materials for the erection of a bridge are not included since a bridge is not a building; that the commodity description 'food products' embraces only such products as are fit for human consumption and does not include canned animal food; that the word 'canned' in the description 'canned goods' refers to the process of canning and not to the receptacle in which the goods are placed which may be metal or glass; that 'groceries' are defined as 'articles for human consumption which are customarily served as food, or which are used in the preparation of food, except ifresh meats,' ... that only rough or unfinished articles are em­ braced by the commodity description 'iron and steel arti­ cles'; that engines and machinery are not included in the term 'iron and steel articles'; that the commodity descrip­ tion 'paper and paper products' does not include news­ papers, magazines, circulars, and other publications; that the commodity description 'fruit and vegetable juices' does not include frozen juices; that gasoline is not a 'liquid chemical'; and that the commodity description 'glassware' does not include sheet glass or rough rolled glass or glass rods.1:3 These restrictions can be very costly to business and to the economy. In the case mentioned above, some of Pre-Fab's customers, manufacturers of prefabricated buildings, were extending their busi­ ness into the mobile home line while mobile home manufacturers were expanding into prefabricated buildings. In actual fact, the distinction in the two lines is becoming increasingly blurred. For example, mobile home manufacturers have recently been producing "double-wides" which are two mobile homes designed to be joined. The commission has held that these are prefabricated buildings

47 rather than mobile homes. The net impact of these decisions is to bar Pre-Fab from providing complete service to its customers and to unnecessarily fragment business with additional costs imposed on all.

Rates

Congress has directed the commission in prescribing just and reason­ able rates, to ensure that they are not unjustly discriminatory or unduly preferential, that they lead to an efficient railway service, and that the overall rates are adequate to provide sufficient earnings to the carriers.14 This injunction has led to a natural dichotomy in types of rate cases: (a) across-the-board changes and (b) individual commodity or commodity group changes. The commission considers the overall earnings of a carrier when considering across-the-board rate increases. On the other hand, when it is concerned with individ­ ual rate changes, the commission focuses on costs of, and the demand for, that service. In the former case, if the carrier or group of carriers is not earning a sufficient rate of return, the proposed rate increase is usually authorized. As Table 5 shows, railroad '"general rate increases" have been generally approved in recent years while motor carrier-general rate increases have been much more frequently denied.

Specific Commodity Rates. For individual commodities, cost is a function of loading characteristics. These include such things as density: the higher the weight relative to volume the lower the cost per pound of moving the good. In addition, the ability to load the commodity compactly is a factor. If the commodity is odd-shaped and cannot be loaded compactly, the costs are higher even though the commodity itself may be quite dense. For example, fresh fruit often cannot simply be piled up in a large boxcar without crushing the underlying produce. Thus, the loading characteristics of the commodity play a major role in the transportation cost. Costs are also affected by the volume that is moyed. A large volume reduces cost, especially if the large volume is moving at one time. Train loads of a single commodity can be handled much less expensively than individual boxcars, which in turn cost less to handle than less-than-carload lots. There are even savings for multiple boxcars, since they can be put together and handled as a unit in switching and servicing. Regular movements cost less than sporadic or periodic movements. Extremely expensive to handle are seasonal movements which have sharp peaks that require a large volume of cars for a short period of time and then produce excess

48 Table 5 ICC RATE CHANGE CASES (January 1965-January 1970)

Rate Changes % of Total Type of Rate Changes Carrier and Case Approved Disapproved Total Disapproved

RAIL Increased rates General 6 4 10 40 Specific 2 2 4 50 Decreased rates General 1 1 Specific 28 15 43 35 Protested rates Too high 5 5 Too low 3 1 4 Unjust, unreasonable,a or discriminatory 19 17 36 47 MOTOR Increased rates General 4 14 18 73 Specific 2 1 3 Decreased rates General 2 2 Specific 10 11 21 52 Protested rates Too high 2 2 Too low 2 2 Unjust, unreasonable,a or discriminatory 5 6 11 55 WATER Decreased rates Specific 1 1 FREIGHT FORWARDERS Decreased rates General 2 1 3 Specific 5 4 9 44

a This category includes cases where rates were too high or too low. Source: Interstate Commerce Commission Reports, vols. 223-237.

49 capacity the rest of the year. Such seasonal changes in cost, how­ ever, are rarely, if ever, reflected in rates that would lead to a more economical use of the facilities. Costs are also affected by the type of equipment. Refrigerated cars are more expensive than insulated cars, which in turn are more expensive than ordinary boxcars. Any special services that must be provided for moving commodities, such as attendants in moving livestock, add to costs. Congress has seen fit to write into the Interstate Commerce Act a provision that imposes complete liability for damage on railroads, truckers, and freight forwarders in moving commodities unless specific exemption has been given by the commission. Thus, any commodity that is fragile naturally carries a higher rate, reflecting the higher probability of damage. High value commodities also carry higher rates, especially if they are fragile. These higher rates for higher valued items should not be confused with the practice of rail carriers, and to some extent motor carriers, of charging higher prices for high valued goods on the basis that the value-of-service increases with the price of the goods. Value-of-service or demand consideration is another factor used in establishing rates and is justified on the grounds that only through value-of-service pricing can the overhead be covered. It is usually contended, without evidence to support it, that there are economies of scale in railroading. 15 Clearly there are no economies of scale in truck traffic, nor are there economies of scale in freight forwarding. Provided the capacity of the industry is appropriate, rates equalling marginal costs for all commodities, where there are no economies of scale, will cover total costs. On the other hand, if there are substantial economies of scale, charging out-of-pocket or marginal costs would not produce sufficient revenue to cover the overhead. Since the ICC believes that the latter is the situation, they have fostered and encouraged price discrimination among commodities on the basis of the value of service. Those commodities, it is argued, that can bear the cost of the overhead should be charged it, while others can be charged less provided they pay at least the variable cost of moving the product. This is preferable to charging everybody average costs, which would exclude some shipments that could be carried at above variable cost, while not capturing sufficient revenue from those that would be willing to pay more. The commission has argued, and the railroads believe, that shippers of high value wares are in a better position to pay more than shippers of low value products. While not always true, there is a certain validity to this position. The freight charge may add a

50 small percentage to the final price of high value merchandise, whereas the same freight charge on a low value cargo could more than double the price on delivery. Because of competition, how­ ever-from trucks, water carriers, and even air freight and other modes-the railroads cannot freely practice value-of-service pricing. Value-of-service pricing can present problems for the commis­ sion in attempting to maintain the validity of rates. As a consequence value-of-service pricing has to be tempered by the importance of preventing such a system from being used to erode the rate structure. If, for example, rates are high on more expensive grades of a certain commodity and low on cheaper grades, shippers will tend to claim that most of their shipments are the cheaper grade. Consequently, the commission has prohibited charging lower rates for used com­ modities than new, since mislabeling is quite possible. Generally, the commission has not permitted .differential rates by final use, even though final use may affect the elasticity of demand for shipment of the product. However, there are exceptions. The ICC has permitted higher rates for the movement of ordinary horses than for the movement of those which are to be slaughtered. Bricks which are used for facing are more costly to ship than common bricks. Lime used for building purposes and chemicals is more expensive to transport than lime for agriculture. In each of these cases the commission has felt that it was sufficiently easy to deter­ mine the final use and so cheating or mislabeling was not a great problem. Generally, the commission has encouraged and permitted higher rates on finished goods than on raw materials. Rate determination is normally left to the carriers with the com­ mission only exercising a veto. Basically, the process is as follows: carriers must file new rates thirty days before they are to be effective. Unless the rates are suspended by the commission either on its own volition or on the protest of others, the rates go into effect. Most rates and rate changes are unopposed and automatically go into effect after the prescribed period. Table 6 presents tariffs and schedules filed during the fiscal year 1971 and their disposition. As can be seen, there were almost 300,000 individual tariffs filed during the year. Of these, 19,000 were criticized and some 4,664 were actually rejected. In judging whether a rate is legal or not, the commission basically considers two criteria. It considers whether the protested rates are unjustly discriminatory or give rise to undue preference. If so, the rates are disallowed. If the rates are not unjustly discriminatory or do not give rise to undue preference, they must be compensatory. Here there are two criteria. The rates must at a minimum always

51 Table 6 U.S. REGULATED INTERSTATE SURFACE TRANSPORT TARIFFS AND SCHEDULES, FISCAL YEAR 1971

Received Rejected by ICC Criticized by ICC

FREIGHT Common carrier, tariffs Rail 57,932 2,991 368 Motor 196,570 11,763 3,545 Water 6,944 207 80 Pipeline 1,866 9 5 Freight forwarder 9,725 690 50 -- -- Total 273,037 15,660 3,957 Contract carrier, schedules Motor 7,127 1,547 384 Water 89 0 0 -- -- Total 7,216 1,547 384 -- Total freight 280,253 17,207 4,341

PASSENGER AND EXPRESS Common carrier, passenger, tariffs Rail 3,636 129 82 Motor 10,400 1,735 234 Water 47 13 5 -- -- Total 14,083 1,877 321 Contract carrier, motor, tariffs Express 55 5 0 Rail 260 33 0 Motor 213 27 2 -- -- Total 528 65 2 -- -- Total passenger and express 14,611 1,942 323 -- Grand total 294,864 19,149 4,664

Source: Interstate Commerce Commission, Annual Report, 1971, p. 108. cover what the ICC considers out-of-pocket cost, which is an approxi­ mation to long-run variable cost. However, if the rate is protested by a carrier of another mode, then the commission usually weighs whether the rate in fact covers fully allocated costs and which mode

52 has the lowest fully allocated cost. Following the dictates of the national transportation policy, the commission reasons that the mode with the lowest fully allocated cost has the inherent advantage and should secure the business. As was pointed out above, fully allocated cost includes arbitrary amounts of overhead. Comparisons between fully allocated costs of two modes are therefore meaningless. The "Ingot Molds" case illustrates the comlnission approach to H intermodal competition and umbrella rate making. ) This 1963 case involved a proposal by the Pennsylvania Railroad and the Louisville and Nashville Railroad to lower their joint rate for moving ingot molds from Pittsburgh, Pennsylvania to Steelton, Kentucky from $11.86 to $5.11 per ton, the same charge as the combination barge­ truck service. The commission found that this new rate was substan­ tially above the long-term out-of-pocket cost of $4.69 for railroads. Since the fully distributed cost for railroads was $7.59, while the fully distributed costs as well as the out-of-pocket costs for barge­ truck was only $5.19, the lower rate was ordered canceled to protect the "inherent advantage" of barge-truck service. The commission specifically rejected the railroad contention that "inherent advantage" should be determined on the basis of out-of-pocket cost. After having been reversed by the appeals court, the ICC was upheld in 1967 by the Supreme Court.17 Two other recent cases illustrate the problem of determining rates. In a case decided in May of 1969, "Grain by Rent-a-Train, IFA Territory to Gulf Ports," lH the commission was faced with a proposal to permit shippers of grain to rent a whole train on the basis of a charge of $1 million per year per train if the railroad furnished the hopper cars or $700,000 per train if the shippers furnished the cars. In addition, a further charge of one-and-a-half mills per ton of grain for each mile of haul would be made, with a minimum charge of $5 per train-mile whether the train was loaded or empty. The "Rent­ a-Train" proposal also guaranteed a minimum average speed of twenty-five miles per hour and provided for a penalty if in fact the carrier did not meet the speed requirement. The grain that was to be shipped under this proposal was to come from central Illinois and be exported. Prior to the time of the proposal, none of the grain affected was being exported. This traffic was new business and would not divert .shipments from any other carrier. However, it was opposed by shippers of grain for export from other areas who did not appreciate the additional competition. Since no other ICC regulated carrier disputed the plan, the commis­ sion considered only out-of-pocket costs in determining whether the rates were compensatory.

53 The railroads presented data showing that the proposed rates would cover their out-of-pocket costs, but the commission, in reject­ ing these figures, argued that overhead costs and fixed costs must be added to the out-of-pocket costs to secure the true long-run out­ of-pocket cost for this plan. Moreover, in computing average over­ head costs, no additional traffic that this new rate would generate could be estimated since such would be speculative. Fixed costs had to be covered on the basis of existing levels of traffic. Such a commission policy can obviously block many innovative rate pro­ posals that depend for their success on generating ne\'V business. Notwithstanding their recomputation of the costs, the commis­ sion found the rates compensatory. Nevertheless, it djsallowed the proposal for two other reasons. First, no minimum volume was specified which meant that a shipper who rented a train and only shipped a low quantity would pay a higher average rate than if he used the regular service. This, the commission argued, was discrimi­ natory even though the shipper always had the choice between the two services. Clearly the shipper would only rent a train if he expected his volume to be sufficient to lower his average costs below the regular rate. It seems undesirable to this author for the commis­ sion to put the burden of a shipper making a mistake on the railroad rather than on the shipper. The second reason for denying the proposal was that the penalty for not meeting the minimum speed requirement was a rebate barred by the Interstate Commerce Act. In contrast, in another recent case the ICC denied a rate proposal because it included a volume requirement. In this case the Wisconsin Power and Light Company, after a feasibility study, decided that a coal-fired power plant on Lake Michigan would be the cheapest way to provide for additional capacity. Wisconsin Power and Light signed a contract with Peabody Coal Company for coal to be deliv­ ered by unit train from Peabody's Elm Mine to Sheboygan, Wis­ consin. The Chicago and North Western Railroad, as the only line operating between these two points, offered to haul the coal in a unit train at $1.56 per ton provided the line was guaranteed a mini­ mum volume of 850,000 tons per year. Such a requirement was obviously necessary to ensure that the road could recoup its invest­ ments in facilities to establish the unit train. However, in its 1970 decision, the commission canceled the rate on the strength of protests of water carriers without even considering the question as to whether the rate covered'the cost of the operation.19 The commission distinguished this case from others in which it approved low unit train rates with minimum volume requirements on the grounds that in the other cases no other modes subject to

54 ICC regulation were being affected. Thus, in the one case the ICC required a minimum volume to protect the shipper from making a mistake and paying too high an average price, and in another case the commission denied a rate because it included a minimum volume requirement which would "exclude" water carriers from competing for most of the business. Table 5 summarizes the data on rate cases found in the Interstate Commerce Commission Reports. As can be seen, a considerable proportion of specific commodity rate decreases were denied for both railroads, motor carriers, and freight forwarders. Table 7 gives the reasons why rate decreases were denied. In almost half of the cases the ICC found that the rates were not compensatory, while a large number of other denials were based on an assertion that the data were inadequate to indicate that the proposal would cover costs. Although there would seem to be no reason to object to rates below fully allocated costs since such a sum is not meaningful, rates below variable costs should produce losses. However, the carriers ,proposing such rate cuts must believe they are profitable. Is the commission in a better position to judge costs than the carriers? Given the antiquated costing procedures used by the commission, it seems doubtful. Thus, it would appear that the shipping public suffered as a result of these cases while the gainers were some protected carriers.

Service

The Interstate Commerce Act directs the commission to De concerned with not only rates but service. Service has many dimensions, and a

Table 7 REASONS FOR ICC DISAPPROVAL OF RAILROAD AND MOTOR CARRIER RATE DECREASES (January 1965-January 1970)

Motor Reasons for Disapproval Railroads Carriers Total

Discriminatory 3 3 6 Data inadequate to show compensatory 3 4 7 Rates do not cover out-of-pocket costs 7 4 11 Rates do not cover fully allocated costs 1 1

Source: Interstate Commerce Commission Reports, vol. 223-237.

55 full discussion of problems of service in the regulated transportation area could take volumes. This section, therefore, will concern itself with only the most significant service problems that have arisen under regulation.

Freight Car Shortage. The most important service problem for rail industry is the apparent periodic shortages of freight cars. While some lines have denied~the existence of any scarcity, the commission has asserted that there is a definite lack of freight cars. The 1971 Annual Report of the Interstate Commerce Commission, for exam­ ple, said: Railroad freight car shortages prevailed throughout fiscal year 1971, rising to more than 15,000 cars per day during heavy loading periods. Stepped up demands for boxcars to handle the annual grain harvest, the government's grain reallocation and export programs, and the peak movements of fall agricultural crops contributed to car supply difficul­ ties. Shipper demands for boxcars to load lumber and forest products caused some shortages in Pacific Northwest loading areas.20 A seasonal dearth of freight cars, especially boxcars, appears to have existed for decades. A shortage, however, is difficult to define in this industry. When a shipper orders freight cars, how soon must they be supplied in order for no shortage to exist? Clearly, the more promptly a railroad furnishes the shipper with cars the better the service, but how good should the service be? In an unregu­ lated competitive market, different suppliers would offer different levels of service with corresponding prices. The consumer, then, would be free to choose that combination of price and service which best meets his needs. However, in the regulated transportation market the consumer is usually faced with only one price and one quality of service for each mode. The fact that during peak demand periods shippers complain of not being able to get boxcars sufficiently fast only indicates that during peak periods they would like the same quality of service they received during slack periods. During off-peak times, they experience higher quality service and so come to expect the same service during peak periods. The reasons for the differential availability of freight cars by season and to different shippers stem directly from regulation. Absent regulation, freight rates would fluctuate to reflect peak and off-peak demand. The Interstate Commerce Commission, however, has required a fixed charge irrespective of the season of the year.

56 This rigid rate structure provides no incentive to even out shipper demands for transportation services. Nor do the rates reflect the opportunity costs of cars during peak periods. To one shipper the value of a car during the peak period may greatly exceed the value to another, yet he has no way to outbid the other shipper for the car. Farmers, for example, can see their produce rot for lack of transpor­ tation while a nearby manufacturer who could easily postpone his shipment has several cars. Thus, fixed rates imply a misallocation of cars among shippers during peak times and that with any given quantity of rolling stock there will be times when it will be more fully utilized and times when it will be less fully utilized and more quickly available to shippers. The only incentive for shippers to divert traffic to the off-peak season is the faster service that is likely to be available. Regulation also affects the profitability of carrying different com­ modities. Shipping charges for some merchandise are high relative to costs and are, therefore, very profitable for the railroads, while the rates for other products are low relative to costs. It is even alleged that some commodity rates are below costs. A recent ICC study indicates that many commodities are carried for less than out-of-pocket costS. 21 Thus, in a time of peak demand when cars are in demand everywhere, the railroad can, in violation of the Interstate Commerce Act, direct the cars to those shippers whose business is most profitable. Compounding the car shortage and contributing to its growing severity are the ICC regulated per diem rates-the rates that one railroad must pay another railroad for the use of its cars. These rates are currently set on the basis of the cost of purchasing a freight car but with no allowance for profit. A recent study done for the Depart­ ment of Transportation has concluded that the per diem rates are inadequate to cover the cost of buying a freight car.22 The cost is calculated on the basis of original cost, a thirty-year lifetime, and a rate of return of 6 percent before taxes. In an inflationary environ­ ment, using original cost to calculate rates will lead to a per diem below that necessary to fully compensate the owner. A thirty-year lifetime assumes no technical obsolescence while a 6 percent return before taxes is significantly under the cost of capital. The result is that per diem does not cover the costs of ownership. Per diem rates since 1964 have been based on a charge per day plus a mileage charge. It is widely alleged-and the allegation appears to be true-that the rates are too low per day and too high per mile. The effect of such a rate structure is to encourage a railroad to keep a borrowed car on its tracks and not to send it back to the

57 owner. Sending it back to its owner involves moving it, which requires paying a high mileage rate, whereas keeping it means having the car available for shippers. Thus, rail managers are encouraged to hoard the cars of other lines while they are discouraged from investing in new cars. With per diem below costs, no railroad finds it desirable to invest in freight cars, especially boxcars. It is much more profitable to secure a boxcar from another line and pay per diem. Under these circumstances, a rail carrier will buy new boxcars only when it has an inadequate number on its tracks to meet its customers needs. Thus, lines which are originators of traffic are forced to purchase or lease new freight cars continuously while watching them being diverted to receiving roads which are chronically deficit freight car owners. The net result of the per diem system, then, is to lead to inadequate investment in new boxcars and a misallocation of exist­ ing cars. Specialty cars, such as refrigerator cars, are operated under some­ what different principles than general purpose boxcars since, under ICC regulations, they must be returned directly to the owning railroad. Therefore, even if a general purpose car is more efficient, railroads tend to be biased toward specialty cars over which they can keep control, whereas new general purpose cars may be promptly "ex­ ported" to other railroads with little return. Partly as a result of per diem and partly as a result of ICC regulation, railroad investment has been increasingly diverted from general purpose cars to .specialty cars. Observers have pointed to a decline in general purpose boxcars relative to specialty cars-see Table 8-as indicating that the former are obsolete. Although boxcars may indeed be outmoded, no such conclusion is warranted simply on the basis of the changes in propor­ tions of freight cars. The system bias against general purpose box­ cars works in the direction of changing the proportion. Too low a per diem also encourages carriers and shippers to make deals that provide the shipper with dedicated facilities to avoid the shortage problem. While there seems to be no doubt that unit trains are"profitable both for railroads and for their customers, and that the potential for rent-a-train also looks good, the low per diem encourages shippers to enter into such agreements in order to assure themselves of ready cars. In conclusion, excessively low per diem contributes to several factors, each of which contributes to a poor utilization of freight cars. Further complicating the problem of freight car supply is a fixed allowance from freight rates for shippers utilizing their own boxcars which is absurdly low relative to the cost of cars. A corporation

58 Table 8 FREIGHT ROLLING STOCK BY CAR TYPE (selected years, 1956-1971)

1956 1961 1966 1971

Plain box 670,844 626,011 464,282 358,887 Equipped box 51,611 52,959 117,418 171,592 Total 722,455 678,970 581,700 530,479 Refrigerator 99,429 90,936 102,297 98,707 Gondolas 278,423 261,827 211,819 185,537 Hoppers 506,411 476,769 426,230 390,398 Covered hoppers 44,539 64,995 97,402 134,883 Flat 48,749 53,858 63,942 75,444 Others 81,385 74,661 59,519 49,165 Total 1,781,391 1,702,016 1,542,909 1,464,613

Source: Interstate Commerce Commission, Annual Report, 1971, p. 30. shipping goods in its own ordinary boxcar receives a reduction in the freight rate of only about half a cent per mile, but the company can receive an allowance of six cents per mile for a specially equipped box car and nine cents for a tank car. Even though the rates for the specialty cars may compensate for the investment in the cars, the allowance for an ordinary boxcar is ridiculous. Faced with the growing car shortage the reaction of the commis­ sion has been to prescribe more regulation. The commission has established rules dealing with "foreign" cars which requires them to be promptly directed back tovvard the owning railroad. Such rules, however, have been only sporadically enforced. In times of acute shortage, the commission has issued car service orders directing that cars be sent from road X to road Y, specifying the use of freight cars, or ordering certain practices in order to temporarily alleviate the worst shortages. In 1947 the commission attempted to alleviate the car shortage by authorizing higher per diem rates in order to give railroads an incentive to send "foreign" cars back to their owner promptly as well as to encourage car ownership. The commission's order, however, was challenged and set aside in court. The court held that the com­ mission had no authority to inject a penalty in the per diem charge, which was solely designed to reflect the ownership costs of the railroad. Subsequently the ICC requested Congress to authorize

59 higher per diems in times of car shortage. After Congress approved this authority in 1966, the commission proposed, and in December of 1969 imposed, higher per diem rates during peak periods. These incentive per diems were based on attempting to secure the owning railroad a 12 percent annual return on boxcars, with high rates for a six-month peak period sufficient to earn 18 percent on investment while during the off-peak periods the rates reflect a 6 percent return on investment. The six-month incentive varies from a $12.98 per day charge added to a basic $10.22 per day charge for a $40,000 boxcar which is less than five years old, to four cents for an over thirty­ year-old boxcar which cost less than a thousand dollars initially. At the time of this writing, this incentive has only been in effect for two seasons and its full implementation has been held up by court challenges. Whether the incentive differential will be sufficient to significantly alleviate the problem is uncertain. J-Iowever, the director of the American Association of Railroads' Car Service Division is forecasting no car shortage for the fall of 1972 despite the Russian orders for grain. He reported at the end of July 1972 that "at the present time we have a substantial number of 40-foot boxcars and also a good number of covered hopper cars in surplus." 23 Although the incentive per diem provides a stimulus for the prompt return of a boxcar unless some very profitable business is available, the net proceeds of the per diem do not accrue to the general revenues of the owners. The commission requires that all credit balances resulting from the per diem be put into a special fund which can be drawn down only to provide for ne\-\' unequipped boxcars for general service. Moreover, in any calendar year the money can only be spent for the purchase of those new unequipped boxcars in excess of the average number built or purchased by the carrier between 1964 and 1968. Any arrears in having failed to maintain this average each year after 1969 must be made up before the funds can be tapped. By this requirement, the ICC is obviously attempting to encourage the rail industry to invest in boxcars and to expand the boxcar fleet by providing a real incentive for the railroads· to purchase more boxcars than they did between 1964 and 1968. Nevertheless, the net effect of this order will probably be that no funds will be spent from this earmarked account. If boxcars are uneconomical, carriers will find it less costly to ignore the funds rather than to invest their own resources in building uneconomical cars in order to be able to buy even more uneconomical boxcars with the earmarked funds. Ironically, since the special account device reduces the profitability of owning boxcars, there may be fewer cars purchased than if the funds were unrestricted.

60 Abandonment. The other major service problem facing the railroads is W~lat to do about uneconomic lines and trackage. Times change, traffic shifts, improved highways divert shippers from rails to trucks, industry migrates from one part of the country to another, and natural resources are exhausted. All of these factors result in many once profitable rail branches becoming no longer viable. The com­ mission's authority over abandonment forces it to weigh the costs of maintaining the services with the losses, if any, from abandoning it. If the line no longer serves a purpose, the commission quickly approves discontinuing the service, but if shippers oppose an aban­ donment application because the service is necessary to their busi­ ness, the commission is caught in a difficult situation. The courts have held, and the commission undoubtedly agrees, that a railroad should not be required to maintain lines which are uneconomic if that results in overall losses for the carrier. As long as the railroad is making sufficient profits to cross-subsidize the unprof­ itable service, the commission mayor may not approve the petition to abandon, although it has ruled that such cross-subsidization will not be permitted indefinitely. In recent years, the commission has become fairly liberal in granting abandonment applications. For example, in fiscal year 1971 95.5 percent of the miles applied for and ruled on were allowed to be abandoned. The commission, however, is currently faced with several applications involving large parts of systems, including the Penn-Central, the Central of New Jersey, and the Missouri-Kansas­ Texas railroads. Since these applications involve regionalized aban­ donments as against the traditional piecemeal proposals, how the commission will rule is uncertain.

Motor Carrier Service. The two major service problems for the motor carrier industry are the small shipment, out-of-the-way com­ munities problem and the household goods problem. Because of ICC regulation, rates for less-than-truckload shipments are depressed relative to rates for truckload shipments, with the result that truck­ ing firms find it more profitable to concentrate on truckload ship­ ments between major points than less-than-truckload movements to out-of-the-way places. As a result, there has been a continuing barrage of complaints that common carriers are refusing to serve small shippers and those shipping small quantities of commodities, especially those shipping to out-of-the-way communities. It is sometimes urged that more regulation is necessary to pre­ vent this small shipment problem from developing or continuing. On the contrary, the evidence indicates that regulation creates these

61 problems and an unregulated industry would provide better less­ than-truckload service to out-of-the-way points. In 1972 the Senate and the House held hearings on several bills designed to amend the Interstate Commerce Act. In those hearings there was not a single user of the agricultural exempt carriers who complained about service. On the other hand, several shippers using regulated com­ mon carrier service complained. In fact, the poor service of common carriers in recent years became such a scandal that in 1970 the ICC was forced to hold hearings on the subject and to adopt special 2 regulations to deal with the problem. -! During those hearings a vast number of shippers filed representations citing examples of poor service. There were forty-four groups of shippers, shipper associa­ tions or others affected by the service, supporting the need to do something, while only eleven groups, mainly representing carriers, opposed. In addition, many trade associations, representing small shippers, supported the need for ICC action to correct the abuses. The complaints themselves make interesting reading. Cook Electric Company of Palatine, Illinois, which manufactures and distributes telephone switchboard protection equipment complained that it is "increasingly difficult to procure the services of carriers for the transportation of small shipments to 'out-of-the-way' towns because many carriers maintain restrictions or minimum weight requirements which apply to service to such points." Emerson Elec­ tric Company complained that it suffered because "Morrison Motor Freight restricts its service from Maysville, Kentucky to shipments which weigh at least 5,000 pounds, while Best Freight Line refuses to provide service at Philadelphia, Mississippi even though it is authorized to do so." 25 More evidence of the effect of regulation and no regulation on services was presented this spring in testimony at the House and Senate hearings on the Surface Transportation Act. Mr. Ben Butler, president of Hunt Transportation Inc., which operates thirty-nine livestock trucks, testified in favor of regulation of livestock trans­ portation. In his testimony he said: Despite near give-away rates, livestock carriers are ex­ pected to provide extra-special service far beyond that expected of other types of carriers. For example, we may be called at 7 o'clock one night and told to have our trucks at the feedlot at 7 o'clock the next morning.... Our drivers are expected to round up and load the cattle, go to the local grain elevator for weighing, go to the pack­ inghouse and unload, return to the elevator and reweigh

62 the empty trucks-and then take the weight slips back to the packinghouse for the shipper. Drivers are also asked to cull out sick cattle, and often to keep cattle from different pens separate so the shipper can tell what the yields are.2fi This appears to be real service. Mr. Ben Butler, however, wanted to be regulated so he would not have to give such service. One of the best pieces of evidence on this service question comes from a 1959 Department of Agriculture study of interstate trucking of exempted frozen food items.27 Asked the advantages and disadvantages of regulated motor carriage, the 107 processors listed only fifty-eight advantages compared to seventy disadvan­ tages. But, more to the point, forty-one of the complaints dealt with the unwillingness of regulated truckers to haul less-than­ truckload shipments or the unwillingness to serve off-line points, while only three processors cited as an advantage of regulated car­ riage a willingness to haul less-than-truckload shipments on back­ hauls. On the other hand, asked the advantages and disadvantages of unregulated carriage, the processors reported seventy advantages and only fifty-four disadvantages, but of the seventy advantages, thirty-three dealt with a willingness to carry less-than-truckloads or to serve out-of-the-way places, and no one cited as a disadvantage either an unwillingness to carry less-than-truckloads or to serve out-of-the-way places. The other service problem of motor carriers relates to the move­ ment of household goods. The problem revolves around two aspects of the movement. First, actual charges are based on ICC approved rates based on actual weight and on any packing, but the mover is often asked to estimate in advance the cost of transporting the goods. Under ICC regulation such an estimate cannot be binding on the carrier, while upon arrival, if the shipper is an individual, payment must be promptly made by cash or certified check-government and business, however, can arrange credit. It should be obvious that individuals moving to a new community may find it particularly difficult to pay the mover upon arrival, especially if the advance estimate was significantly under the final charge. A recent ICC survey showed that 45 percent of the actual charges exceeded the estimates. In 12 percent of the cases it exceeded the estimates by 20 percent or more.28 The second problem shippers face in moving household goods is ensuring the timely pickup and delivery of their furniture. The ICC survey cited above found that 65 percent of the movers promised delivery dates, and 32 percent of those set for private individuals were not met. Another survey sponsored by the American Movers

63 Conference found that 25 percent of the household goods were delivered late and over 12.5 percent were delayed six days or more. In February 1970 the ICC promulgated a new set of rules dealing with the movement of household goods. These rules require "reason­ able dispatch" of the movement of goods, defined to mean the move­ ment of goods between the agreed dates. Inasmuch as no penalty­ except ultimately decertification-was prescribed for failing to move the household goods within the agreed dates, the effect of this order may not be significant. Another new rule dealt with the tendency to underestimate moving costs. If actual costs are more than 10 percent over the estimate, then the mover must extend credit for 15 days for all sums owed over 110 percent of the estimate and he must report all such cases to the ICC. As with the other service problems discussed, service difficulties in the household goods areas stem mainly from regulation. The peak use of this system occurs in the summer months, with 61 percent of the moves occurring within the six-month season from May to October. Four of those months account for almost half of the entire year's movement. Rates are now uniform throughout the year with the consequence that there is no incentive for shippers to transfer their business to the slack season. Recently one moving company, Republic Van and Storage, pro­ posed that a lower rate be charged during the slack season. The com­ mission initially approved, but was taken to court by the Movers and Warehousemen Association of America, with the result that in 1970 the commission, upon reconsideration, decided that inasmuch as the rate could only be secured by business shippers, which consti­ tuted 29 percent of the movements of Republic Van and Storage, the proposal was unduly discriminatory.29 The proposal was denied. Analogous to the boxcar problem, late delivery of household goods is at least partly a function of the uniform rates required by ICC policy throughout the year. Commission regulation also tends to encourage rate underestimates because some householders who fail to realize that estimates are nonbinding move their belongings by the firm making the lowest estimate. In an unregulated market, a shipper would be in a position to negotiate a firm rate and a firm date for pickup and delivery with appropriate penalties for nonperform­ ance-and most of these problems would disappear.

Mergers

Another important regulatory topic is the control of mergers, consoli­ dations and joint control of various carriers. ICC merger policy can

64 affect the market structure of the transportation industry. A liberal policy could lead to a significant decrease in competitiveness, while a more rigid policy based on antitrust principles might maintain a reasonably competitive structure. Given the strict controls on entry that the Interstate Commerce Act requires and that the ICC enforces, mergers by regulated carriers can be very profitable. Under regulation, mergers may lead to monopoly with little fear of new entry. In an unregulated industry, if sufficient mergers tend towards a temporary monopoly, entry will soon eliminate it. As a consequence of this inclination for regulated carriers to consolidate their enterprises, extra vigilance is necessary if competition is to be maintained.

Railroads. Neither Congress nor the commission, however~ has viewed the maintenance of competition as important in a regulatory environment. In fact, competition has been viewed with some hostility by the regulatory agency which has found that it results in changes that make commission control more difficult. Given con­ gressional interest in improving railway efficiency and dealing with the "weak-road/strong-road" problem, the Transportation Act of 1920, which gave the ICC control over entry and abandonment, also authorized the commission to draw up a plan for the consolidation of major railroad companies into viable competing units. The charge to prepare a consolidation plan was eliminated in the act of 1940, but in its place, the commission was authorized to approve the consolidation, including any intermodal combinations, of all surface modes-railroads, motor carriers, and water carriers. In approving any intermodal combinations between motor carriers and railroads, the commission is required by law to find that the transaction will be consistent with the public interest, will enable such carrier to use the service by motor vehicle to public advantage in its operations and will not unduly restrain competition. These requirements for intermodal combinations are much stricter than those between car­ riers of a like mode, although intermodal combinations are less likely to reduce competition than intramodal ones. For intramodal railway mergers, the commission is directed to give weight to the following considerations among others: (1) the effect of the proposed transaction upon adequate transportation service to the public; (2) the effect upon the public interest of the inclusion, of failure to include, other railroads in the territory involved in the proposed trans­ action; (3) the total fixed charges resulting from the pro-

65 posed transaction; and (4) the interest of the carrier em­ ployees affected.30 The commission is authorized to require the inclusion of other railroads-upon their petition-in any proposed consolidation and to provide for the protection of the jobs of employees of all affected railroads for four years. All mergers approved by the commission are exempt from state control and from the antitrust laws. Notwithstanding the antitrust exemption, the Justice Department has intervened in many of the most significant railroad merger hear­ ings to point out their adverse competitive effects. The Supreme Court, ruling on railroad mergers, has held that, while the ICC cannot ignore antitrust law, it is only one factor to be weighed.31 The com­ mission, according to the Supreme Court, must weigh any proposed loss in competition against the expected gains in terms of efficiency, better service, and lower cost from the combination. With the development in recent decades of vigorous intermodal competition, the commission has de-emphasized the importance of intramodal competition among carriers in consolidation cases. Starting in 1955, a wave of railroad mergers has led to a signifi­ cant restructuring of the industry. From 1955 to 1972 there have been fifty-nine consolidation proposals, of which the commission has approved forty at the time of this writing. Six have been denied, six have been withdrawn, three were dismissed, and, as of the begin­ ning of 1972, four were still pending. As these numbers indicate, two-thirds of the proposals were approved, including two gigantic mergers: Penn-Central and the Burlington-Northern, which created railroads larger than any ever seen before. While the commission has tended to look with benign approval on a consolidation proposal, it has not taken such proposals lightly. The Burlington-Northern merger case, for example, was filed with the Interstate Commerce Commission in February 1961. Five years later the commission ruled-on a six to five vote-against the merger, but upon reconsideration, the merger was approved and finalized in March 1970, nine years after the original application. The Penn-Central case took five years and 129 days of hearing before two examiners, creating 19,750 pages of transcript containing 5 mil­ lion words. There were 291 prepared statements submitted with 352 exhibits by 463 witnesses and 338 attorneys. Commission approval of these combinations has resulted from the belief that the public benefits to be secured from combinations are large and that very little is to be lost from the reduction of competi­ tion, which in the view of the ICC is only destructive. According to the commission, the public benefits whenever a weak railroad is

66 combined with a strong line to produce a viable system with the traffic from the strong sections supporting the less profitable services. This policy in effect requires some shippers to cross-subsidize others unless the combination can reduce costs on the weak lines. If not, subsidization is the result, but while it may be that in certain instances a service that cannot pay for itself is in the public interest, in those instances a subsidy from the public and not other shippers would be more appropriate. Cross-subsidization hides the cost of aid and arbitrarily allocates its burden. More appropriately, federal or state tax monies should be appropriated for any specific subsidy. Congress has recently recognized this principle in passenger transportation by establishing AMTRAK to divorce rail passenger carriage from freight. Prior to this act, freight transportation had cross-subsidized rail passenger commerce, buf now any passenger deficit must .be borne by the taxpayers. The commission also apparently believes that the combination of two weak railroads will result in a larger and stronger system, stemming from a reduction in costs. No doubt it will produce a larger railroad, but whether it will produce a more profitable one is less certain. Whether combinations of several roads will lower average costs depends on the existence of economies of scale. Almost from the beginning of railroading, many observers have attributed to the industry substantial economies of scale. Yet in recent years, a number of economists have studied the subject and concluded that there are no economies of scale for larger railroads. Only one econometric study found statistically significant economies of scale, and it was based on 1936 data.:32 Other investigations based on post-war data found none. Professor Borts, who estimated costs as a function of output for large railroads and small railroads and for different regions of the country, found no economies of scale for the larger lines, no appreciable economies of scale overall, and increasing costs in the East.:~3 Griliches also fit cost functions and found that decreasing cost functions are not prevalent in the East or among the bigger railroads.:34 Friedlaender and Moore, using a variety of statistical techniques, also secured results consistent with the proposition that there are no economies of scale for larger rail­ roads.35 The statistical evidence indicates that there are no econo­ mies of scale which would result in appreciable cost savings from mergers of large rail systems. Additional evidence on the "benefits" of mergers came from a Department of Transportation staff study on proposed western rail­ road mergers.36 One of the findings of this study was that actual savings from past mergers had often been less than estimated for

67 several overlooked reasons: The plans proposed for integrating the combination of facilities were often not fully carried through; the proposal normally did not forecast any diseconomies of scale; and there were no outside checks on the railroads proposing the merger in estimating the benefits from the combination. This staff study concluded that these factors biased the expected benefits of mergers significantly upwards with the result that several recent combina­ tions had had disappointing results. This report quotes Robert Gallamore who, in a recent Ph.D. thesis found that "... in most circunlstances there have been difficulties in achieving merger sav­ ings." 37 He investigated nine mergers and found one resulted in large to medium savings, one in medium to small savings, and one in small savings. The others either resulted in no significant savings, or in one case, extra costs. A staff study prepared for the Senate Commerce Committee by Richard J. Barber found that rail mergers since 1958 "have generally fallen far short of their claimed cost savings." 38 It goes on to claim that "the experience of the last fifteen years simply does not estab­ lish that mergers are a generally useful way of increasing efficiency, eliminating excess capacity, or improving rail service." 39 On its face, the Penn-Central merger appears to have resulted in significant extra costs. Neither the Pennsylvania Railroad nor the New York Central system was noted for large profits before the combination, but they were covering their expenses. Promptly after consolidation, however, the combination went into bankruptcy. The evidence, therefore, indicates that the gains from consolida­ tions are illusory. Yet the commission continues to ignore it, as well as the reduction in competition from combinations, in a vain effort to achieve lower costs by merging firms. This policy has in recent years significantly reduced the competitive structure of the railroad industry with the concomitant curtailment of performance-without engendering offsetting economies.

Motor Carriers. Almost all observers of the trucking industry believe that there are no significant economies of scale among trucking firms. The few statistical studies done on economies of scale in trucking tend to support this position, but more relevant is the existence of many small firms in unregulated agricultural motor carriage as well as in unregulated carriage in Canada and in Australia. Nevertheless, in the context of the ICC regulation, there are real potential gains from certain types of mergers. If one firm has authority to carry commodities that flow generally in one direction, merger with a firm that has authority to carry goods that flow in the opposite direction

68 will lead to a more balanced situation and lower the average cost of moving all the traffic. In addition, geographical restrictions on certificates may limit the ability of motor carriers to provide all the service their customers desire, thus providing incentives to combine firms in order to offer a more complete service. The commission, in considering merger proposals among truck­ ing firms, has given little weight to the possible reduction in com­ petition from such combinations. On the other hand, if a proposed consolidation might adversely affect competitors, Le., other carriers, the commission'has not been willing to grant authority. For example, a firm, which had authority to operate between the West Coast and S1. Louis/Chicago, and which wished to merge with a firm operating to the East to provide a nationwide carrier system, was denied per­ mission by the ICC on the grounds that it would result in the exclusion of other East Coast carriers from that business.4o Whenever the commission authorizes a combination, the result­ ing carrier has only the authority to operate that was held by the two carriers prior to the combination. If the first carrier operated between A and B and the second carrier operated between Band C, to ship goods from A to C would require a movement from A to B and then from B to C. Such restrictions, while they prevent a change in the competitive structure, often result in circuitous routing of commodities which leads to higher costs.

69

CHAPTER V

EFFECTS OF REGULATION

In discussing the history of regulation, and how it works, many of its effects have been indicated. This chapter, therefore, is primarily devoted to the summarization of the effects of regulation on prices, on service, on market share, and on the economy.

Prices

On the average, regulation has increased prices and rates. Ever since the passage of the Transportation Act of 1920, Congress and the commission have been concerned with the economic health of the transportation industries, especially the railroads. Notwithstanding the fact that sufficient earnings have been an important objective, the commission, as Table 5 makes clear, has not automatically approved all rate increases. The commission has been concerned with attempt­ ing to balance the competing forces of shippers and of carriers. In attempting to reduce competition within the transportation industry while still requiring adequate service, the commission inadvertently has imposed higher costs on carriers which, naturally, has led to higher rates. As can be seen from Table 5, railroads requested forty-three specific rate decreases and only one general rate decrease in a six-year period, while simultaneously applying for only four specific rate increases and ten general increases. On the other hand, motor carriers have filed for eighteen general rate increases-almost twice the general rate increases proposed by railroads-at the same time requesting only twenty-one specific rate decreases-half the number filed for by the railroads. These data suggest that the commission has been holding many rates higher than the railroads find in their own best interest. If

71 regulation was reduced or eliminated, lower rates for many products would likely be posted by the rail carriers. As Table 5 shows, most of the rate increase proposals were general across-the-board changes, whereas the rate decreases were normally for specific commodities. The table also shows that rate decreases were not the over­ whelming proportion of the proposed rate changes for motor carriers, as they were for rail carriers, which suggests that there was some­ what less pressure for rate decreases among motor carriers. If the difference between rates and costs is reflected in the pressures for rate cuts, rail rates must be higher relative to expenses than are truck rates. Yet we know from a number of studies that trucking rates, absent regulation, would fall considerably. After the courts held that frozen fruits and vegetables came under the agricultural exemption, rates for these commodities declined sharply-an average decline of 19 percent.1 The courts also found that fresh dressed poultry and frozen poultry were exempt commodities, with the result that rates on them also fell considerably with the unweighted average rate decline being 33 percent, according to a DOA study.2 On the basis of another study, using Canadian data, James Sloss concluded that "had regulation not been applied to U.S. common carriers, it may be surmised that their revenues per ton mile would have been reduced by this 6.73 percent." 3 Since regulation tends to be less strict in Canada than in the United States, and since railroads have considerably greater freedom in pricing in Canada than in the United States-a fact which puts downward pressure on truck prices-Sloss's procedure tended to underestimate the impact of regulation on U.S. motor carrier rates. The true inflation in rates due to regulation must lie above 7 percent and could easily be 20 percent or more. Actually, the Department of Agriculture studies may underesti­ mate the amount that rates on nonagricultural-related products would decline if regulation were abolished. A recent study by Olson demonstrates that class rates of motor carriers are reasonably con­ sistent with a profit maximizing, price discriminating mode1.4 Her model predicts that the percentage markup over costs of moving a commodity is a function of the cost of the product per hundred­ weight. Agricultural commodities, in particular poultry and frozen fruits and vegetables, have a very low cost per hundredweight for production. Hence, under her model, a profit maximizing cartel would establish a relatively low markup over the cost of hauling these commodities while rates for other, more typical products, should be higher relative to costs. In other words, the rate declines after deregulation of 19 percent and 33 percent are for commodities

72 whose rate markups would be less than average. Therefore, it is quite possible that, on the average, rates are inflated for trucking greater than 20 percent.

Freight Forwarding. Table 5 also presents the frequency of rate increases and rate decreases for freight forwarders. All rate pro­ posals by freight forwarders are for decreases. Downward pressure on rates is evidenced here also. Indirect evidence on the cost/price margin for freight forwarders indicates that it has been growing. The freight forwarding business is mainly one of collecting small shipments, combining them into truckload and carload lots, utilizing a common carrier to move them to a breakbulk point, and finally distributing them to the ultimate consignees. The major cost of freight forwarding is the outlay for common carrier transportation. The other major component arises from the labor of collecting the shipments, sorting and combining them, and then breaking up the load into individual shipments at the final point for distribution. Table 9, Column (a), exhibits the costs of freight forwarding minus the payment to rail carriers, water carriers, and motor carriers-that is, the costs of administration and handling the shipment. Column (b) divides those costs by the amount of tons moved by freight for­ warders and presents the outlay per ton. Labor charges have obvi-

Table 9 FREIGHT FORWARDER OPERATING COSTS (selected years, 1936-1970)

Costs of Administration Costs of Administration and Handling Minus and Handling Employee Compensations Year $ millions Per ton $ millions Per ton (a) (b) (c) (d)

1936 18.4 n.a. 1942 31.6 7.50 13.6 3.22 1950 68.9 16.36 36.7 8.73 1955 98.7 21.02 50.3 10.71 1960 127.2 31.02 69.6 16.98 1965 152.9 38.29 97.7 24.46 1970 206.9 49.19 124.6 29.62

Source: Transport Economics, May 1971, and Freight Forwarder Investigation, 229 I.C.C.201.

73 ously escalated rapidly in recent years. Consequently, Column (c) subtracts the payment to employees from the cost of administration and handling, leaving figures representing mainly profit and a return on fixed assets. Column (d) shows these costs per ton. It can be seen that costs have increased significantly over the period of regulation. In fact, in 1970 the return on investment per ton including profit [Column (d)] was 820 percent greater than the costs in 1942, when freight forwarders were first regulated. One can only speculate about the reasons for such a rapid increase in freight forwarding payments to and for capital. It may be that regulation has imposed significant costs on freight forwarders as well as other modes of transportation. Or, it may be that the freight forwarding business has changed and become more capital intensive. Such a change could easily be the result of regulation, which tends to encourage a substitution of capital for labor because the larger the rate base the larger total profit the regulated firms can earn. Column (d) also includes profit to the industry, both cost of capital and any profit stemming from monopoly power of the freight forwarding industry. Since Table 3 indicates that freight forwarding is at least as attractive an industry to enter as the motor carrier industry, judging by the attempted rate of entry, it seems fair to presume that rates are significantly inflated in this industry as well. Finally, the history of the industry indicates that regulation may have raised rates substantially. The 1938 study of the freight for­ warding business by the Interstate Commerce Commission claimed that the industry was growing very rapidly.5 They reported the number of freight forwarders as twenty in 1936. Six years later the number of firms had more than doubled to fifty-one. Since 1942 the number of such firms has increased only slightly. In addition, while data on tonnage moved by freight forwarders prior to regulation are nonexistent, it is apparent that the industry was growing rapidly not only in terms of number of firms but also in terms of total volume handled. Since regulation began, total tonnage handled has been stagnant in the face of a growing economy and increased less-than-truckload shipments. One possible hypoth­ esis is that over time rates have gone up sufficiently to keep total freight forwarder shipments constant.

Water Carriers. In 1971 only 6.7 percent of water ton-miles were regulated. Although there is little data on the effect this regulation has had on rates and costs in water carriage, Karl Ruppenthal did estimate the cost of strictly enforcing an ICC ban on mixing exempt

74 and nonexempt commodities in the same tow.6 He found that this would raise the cost per ton-mile from 2.30 mills in 1967 to between 3.02 mills and 3.34 mills depending upon certain assumptions of the size of the economic tow handled. This implies that cost would have gone up between 31 percent and 45 percent per ton-mile. While Congress has repealed the ICC's ruling and permitted barge compa­ nies to operate under older and more flexible practices, it seems quite likely that regulation has had some impact on costs and rates in water carriage; however, it is not possible to identify the magnitude.

Service

The effect of regulation on service has been indicated in a prior chapter. The reader will recall that regulated motor common carriers often refuse to handle small shipments and shipments to out-of-the­ way places, whereas users of exempt carriage continuously lobby to continue the agricultural exemption. They point to the good service under exempt carriage, and justifiably fear that regulation would reduce the quality of service. For example, in a recent Inter­ state Commerce Commission case the need for exempt carriage was given as follows: Gold Kist [a producer and marketing cooperative of over 125 million chickens a year] believes that it would be unable to move its traffic by regulated carriers because of its need for four to eight stops a truckload with exact timed deliveries.7 In the same case, Pillsbury Company, another large producer of poultry, testified: Few shipments of the involved commodities are truckload in volume and most require approximate six to eight stop­ offs for partial unloading. As motor common carriers will not usually provide that many stops, Pillsbury assertedly will turn to private carriage if the involved commodities are ... 'not exempt.' 8 Studies by the Department of Agriculture show that the exempt hauler provides many services that his regulated counterpart does not or cannot. Unregulated carriers provide small shipment deliv­ eries, multiple origin and destination duty, and time oriented sched­ uling of pickup and delivery. A spokesman for the Department of Agriculture testifying before Congress in 1972 said: The benefits of the unregulated trucking system are required if we are to maintain the present marketing system for farm

75 and food products. Food items are not comparable to indus­ trial products. The perishability of the product, even when frozen, limits the duration of storage or warehousing.... The quality of the exempt hauler's equipment is good. Service is the selling point of the exempt hauler.... Because of the effectiveness and efficiency found in motor carriers operating under the exemption, we strongly oppose any curtailment of the agricultural exemption. Increased truck regulation of agricultural commodities will only result in more shipper-owned trucks rather than greater use of common carriers. The higher transportation bill will in­ crease marketing costs and mean less income to the farmer and a larger food bill to the consumer.9 Normally the maintenance of above cost rates with rival firms generates non-price competition which often takes the form of better service. While such a tendency could be expected in trucking, the regulatory constraints have apparently been such as to lead, on balance, to a decline in the quality of service to most shippers.

Railroads. The effect of regulation on railroad service has already been amply described above. Regulation requiring uniform rates throughout the year has contributed significantly to the periodic boxcar shortage during peak seasons. Regulation, by providing an inadequate per diem and an inadequate private car allowance, has discouraged investment in new boxcars and led to the hoarding of other companies' freight cars. The net result has been a diminishing fleet of boxcars and continuous complaints by shippers, all resulting from regulatory practices. It can be argued that, on the positive side, regulation has discour­ aged and prevented the immediate abandonment by railroads of unprofitable lines. While no railroad should be forced into main­ taining an unprofitable line indefinitely, too precipitous an abandon­ ment might create rather costly adjustments for many shippers. On the other hand, if railroads were free to abandon trackage at will, the cost of keeping a service in operation would reside with the communities and shippers involved. If they wish to offer the railroad sufficient subsidy in addition to the rates to cover carrier losses, the service would be offered. If they are not willing to offer such a subsidy, the service is unjustified. Therefore, while the existing system does prevent the railroads from precipitously abandoning service, it also tends to foster cross-subsidization, a practice which forces other shippers to support the uneconomic service. Under

76 current law the test for an abandonment proposal is one of legality and not one of economic viability. Regulation, by inhibiting rate flexibility, has discouraged innova­ tion with the result that costs are higher and services poorer than would be true otherwise. For example, in the "Big John" case of 1961, the Southern Railway System proposed a cut in grain rates of 60 percent based on the use of a new aluminum hopper car that cut costs significantly.lO To be economic, however, the new cars had to generate large increases in traffic. The commission, on a review, set aside the new rate. In August 1965, four years after the original rate filing and following a successful appeal to the Supreme Court, the ICC reversed itself and found the rates legal. Although the Southern Railway was eventually successful-albeit at a signifi­ cant legal cost-the full exploitation of this innovation was signifi­ cantly retarded. Another example of how regulation held up innovation was described by Paul MacAvoy and James Sloss in a study of unit coal trains. They found that ICC regulation held up the introduction of 1 such trains for about four years. ! ICC control prevented railroads from offering "tailored" trainload rates for specific markets which would have made the introduction of unit trains profitable in 1958. Rate flexibility is often necessary to innovation with new tech­ nology or new techniques. Carriers may be reluctant to experiment if a proposed rate must be permanent. Thus, inhibiting experimenta­ tion in rates may delay innovation in hardware.

Market Share

In the decade of the 1960s, the market share of each of the three modes of surface freight transportation-railroads, motor vehicles, and water carriers-remained roughly constant. Prior to this decade, as can be seen from Table 10, the market share of railroads fell nearly 30 percent-from almost 70 percent in 1940 to slightly over half of the intercity ton-miles twenty years later. Motor vehicles, on the other hand, increased their share from slightly over 10 percent to slightly over one-quarter of the market by 1960. Throughout this period water carriers continued to hold 20 percent of the market. To what extent the changes and market shares have been affected by regulation is uncertain. In spite of the fact that motor vehicles were brought under control by the federal government to protect railroads from their competition, that objective failed. While no good data exist on the percent of intercity ton-miles carried by

77 Table 10 MARKET SHARES OF INTERCITY NON-PIPELINE FREIGHT, BY TRANSPORTATION MODE (selected years, 1940-1970)

Railroads Motor Vehicles Water Millions of % of Millions of % of Millions of % of Year ton-miles total ton-miles total ton-miles total

1970 768,000 51.6 412,000 27.7 307,000 20.6 1965 721,055 53.7 359,218 26.8 262,421 19.5 1960 594,855 54.1 285,483 25.9 220,253 20.0 1955 654,573 59.8 223,254 20.4 216,508 19.8 1950 628,463 65.1 172,860 17.9 163,344 16.9 1940 411,813 69.6 62,043 10.5 118,057 20.0

Source: ICC Annual Report, 1971, and Statistical Abstract of the United States (Washington, D. C.: U.S. Bureau of the Census, 1971), Table No. 831. motor vehicle prior to regulation, after 1935 trucks took an increasing share of the market away from railroad.:;. Whether this was because of, or in spite of, regulation cannot be said with any certainty. Harbeson, in a recent study of the relative costs of rail and motor carriers, found that for almost all mileage blocks rail carriage had a cost advantage, with this advantage growing with distance. He reported: Thus even with very generous allowances for the limitations of the underlying data the magnitude of the economic loss resulting from the misallocation of traffic between rail and for-hire intercity truck transportation must be conceded to be impressive.... Even the generally accepted proposition that trucks have an advantage over rail for short hauls, while true for particular segments of traffic under certain condjtions, appears not to hold for short haul traffic as a whole.12 One of the best studies of transportation competition also found that for all but the shortest hauls trains have an advantage over trucks. This work indicated that 37 percent more revenue ton-miles could be handled by rail than water at the same total COSt.13 This author has made no independent study of the question of the allocation of traffic among modes, nevertheless a casual reading of rate cases indicates that railroads have more often gone after

78 water traffic in recent years than truck traffic. Moreover, given that motor carriers were brought under regulation to protect railroads, and assuming that the ICC has wanted to provide impartial regula­ tion among all regulated carriers, it seems unlikely that the commis­ sion would have operated in such a way as to shift a significant portion of traffic from rail carriers to motor carriers. There does appear to be some indication that regulation has deterred the growth of the freight forwarding business. As indicated above, the number of freight forwarders and the amount of the traffic handled grew rapidly prior to regulation, but since regulation the number of freight forwarders has expanded only from fifty-one to sixty-five with almost no change in the total tonnage shipped. In 1942 freight forwarders received 4,219,000 tons of freight from ship­ pers, while in 1970 freight forwarders collected 4,206,000 tons of freight from shippers, down 13,000 tons from the 1942 figure. 14 The freight forwarding business, in other words, has not grown at all in the period of time it has been regulated. In the light of the hostility of the ICC to freight forwarders, as exemplified in the 1938 study and their recommendations to Congress, it is not surprising that freight forwarders' business has remained stagnant.

Cost to the Economy

All impartial observers of transportation regulation have concluded that its costs to the economy are substantial. While no individual has yet been able to identify and quantify all of the costs imposed by regulation on the economy, major elements have been estimated. The most complete set of estimates of cost of regulation to the economy were prepared by this author and are being published 1 elsewhere. :) To estimate the waste regulation imposes on common carrier trucking, this author assumed that if regulation were abolished common carrier trucking rates would decline an average of 20 per­ cent. This assumed percentage reduction was based on the rate decrease experienced when frozen fruits and vegetables, and fresh dressed and frozen poultry were deregulated by the courts on the grounds that these products came under the agricultural exemption. Such a decline in rates on the same volume of traffic would lead to a 20 percent decline in revenues. Assuming that at these lower tariffs, all costs including a minimum profit are being covered, this reduction would have to come from profits, from lower costs or both. Since profits could only absorb a small portion of the decrease" cost reductions would have to absorb most of it. Depending on the

79 method of estimating how much of the cut in revenue could be absorbed by profits, the curtailment in expenses would have to be between $1.4 billion and $1.9 billion. (See Table 11 for detailed figures.) Regulation, by ~rohibiting private motor carriers from soliciting backhauls, imposes significant inefficiencies on that segment of the industry. To estimate the loss involved in private trucking, the author assumed that, absent regulation, private trucks would be as successful as common carrier trucks in securing backhauls. Or more specifically, it was assumed that private owners of each type of tractor trailer truck-van, open top vans, platform, and insulated­ could achieve the same rate of utilization as common carriers secured with the same type of equipment. Since regulation has generated excess capacity in common carrier operations, this is a conservative assumption. On this basis, assuming that only trucks owned by certain sectors of the economy could secure these backhauls, the author found that the savings would be about $100 million. If all private motor vehicles of the general type were able to do as well as common carriers, the saving would be as high as $1 billion.

Table 11 ESTIMATES OF THE ECONOMIC LOSS FROM ICC REGULATION IN 1968 ($ millions)

Type of Loss Low Medium High

Inefficient use of: Common carrier trucks 1,400 1,690 1,890 Private trucks 100 200 1,000 Rails 1,700 2,000 2,400 Water carriers 200 300 300+ ------Subtotal 3,400 4,190 5,590 Loss from traffic carried by: Trucks instead of rails 200 1,100 2,900 Water carriers instead of rails a a a Loss from traffic not carried 175 300 400 ------Total estimated 3,775 5,590 8,790 a Not estimated. Source: Moore, The Feasibility of Deregulating Surface Freight Transportation (Washington, D. C.: Brookings Institution, forthcoming).

80 This author estimated the loss to rail carriers from regulation as between $1.7 billion and $2.4 billion. The lower figure was based on the assumption that in the absence of regulation, rail carriers would move the same total tonnage as they do with regulation. If, as Harbeson, Meyer, Friedlaender and others claim, the railroads would be able to increase their share of traffic, then the $1.7 billion is an underestimate of the loss due to regulation of rail carriers. The high figure was taken from Professor Friedlaender's estimate of the economic loss due to excess capacity generated by regulation. 1H The loss regulation imposes on water carriers was only partly identified. Based on Karl Ruppenthal's study of the added expenses inflicted by the ICC's strict interpretation of the law, the cost of regulation varied from $200 to $300 million. 17 However, it should be recognized that the law has been changed. At least this portion of the cost is no longer being borne by society. While this author remains unconvinced that the amount of traffic that would shift from motor carriers to rails is substantial, other authors have clearly predicted such a shift. Morton J. Peck estimated that rails could attract no more than 10 percent of truck revenue under deregulation.n~ On this basis the loss from the misallocation of traffic between modes would be $200 million. Harbeson, on the other hand, found the numbers to be much higher, ranging between $1.1 billion and $2.9 billion.19 No data are available to estimate the loss due to the carriage by water carriers of traffic that would be more economical to move by rails. Traditionally, the loss from monopoly pricing has been esti­ mated by simply looking at the traffic that would have moved had pricing been set at competitive levels. This economic waste is small compared to the other elements. This author has estimated that it ranges between $175 million to $400 million with the higher number being Ann Friedlaender's estimate.2o As can be seen from Table 11, the total of these losses is sub­ stantial. It falls somewhere between nearly $4 billion and almost $9 billion. Yet not all elements of the loss from regulation are in fact clearly identified. With many of the figures chosen on the basis of conservative assumptions, it would not be unreasonable to expect that elimination of regulation would result in a saving to the economy, in terms of resources, as high as $10 billion a year.

81

CHAPTER VI

ALTERNATIVES

Given the huge "tax" imposed upon the economy by regulation, the poor service inflicted on shippers by regulation, and the inflated and discriminatory rates exacted by regulation, alternatives to the current system must seriously be considered. There are two possible direc­ tions such alternatives may take. Regulation may be strengthened and increased, or alternatively, regulation can be reduced or elimi­ nated. As mentioned in the introduction to this paper, these two possible alternatives are reflected in the two bills Congress held hearings on in 1972.1

Surface Transportation Act of 1971 The industry-backed bill, called the Surface Transportation Act of 1971, would have provided for $5 billion in loans for surface trans­ portation companies. It would have required that the ICC develop criteria for determining the carriers' revenue needs and to permit expedited rate adjustments necessitated by cost increases. The bill would also have provided for speedier handling by the ICC of rail line abandonments and would have prohibited the heavier taxation of transportation properties by states and other real estate. In the regulatory area the bill would have required an expansion in regulation. The following products which are now carried by motor carriers under the agricultural exemption would have been made subject to ICC control: redried tobacco, shelled peanuts, imported and cooked fish (including imported and cooked shell fish), processed poultry, processed milk products, processed eggs, and all ordinary livestock. In addition, the bill would have required the publication of bulk commodity rates carried by exempt water car-

83 riers, and would have prohibited most rate changes without thirty­ days notice. Of course, such a proposal would limit the freedom of bulk carriers to change their rates and would tend to foster higher rates and more cartel-type activity. The last few provisions were vigorously opposed by agricultural interests. For example, in a statement before the Surface Transpor­ tation Subcommittee of the Senate Committee on Interstate and Foreign Commerce, the American Farm Bureau Federation said: "The service provided by exempt carriers is superior in many circum­ stances to regulated carriage." The Farm Bureau provided the following listing of some of the areas in which exempt carriage provides a superior service to regulated carriage: (A) Cornman carriers rarely provide service adequate to the shippers' needs for the transportation of feeder or other livestock or other farm products from one farm to another farm. (B) Most cornman carriers do not load on farms, and in general we doubt their ability to do so. Many destina­ tions for farm shipments-for example, processing plants located in a small town or in the open country­ are not reached by common carriers. (C) Many cornman carriers, rail and truck, pass through farm and rural areas without stopping and with little interest in serving such areas. In many cases loading or unloading facilities are not available to serve shippers in farm and rural areas. (D) Common carriers are historically inefficient at handling less than carload, or less than truckload, shipments. The Interstate Commerce Commission has on innumer­ able occasions cautioned them to improve their small shipment service. Farm products are often shipped in comparatively small amounts. Exempt carriers provide superior service in such instances. In Ex Parte MC-77, "Restrictions on Service by Motor Cornman Carriers," the Commission criticized carriers for tariff restrictions "aimed at limiting service on small shipments and on traffic that either originates at or is destined to points in rural or relatively inaccessible areas.... In addition to tariff selectively based on size, weight, origin or destination of shipments, carriers sometimes maintain . provisions which exclude the transportation of certain commodities which they are authorized to transport."

84 (E) Good marketing commonly involves prompt and fast transportation. If cargo must be loaded at 2 :00 a.m. to reach a market at 6:00 a.m., exempt carriers accommo­ date themselves to this need. We doubt that common carriers would adapt their schedules to meet the needs of farmers in this respect. (F) It often is impossible to get from a particular origin to a particular destination by common carrier except by circuitous routing, or interchange of equipment or load­ ing-which increases the time required, adds expense, and may adversely affect quality. Exempt carriers can move from any point to any other pojnt without restric­ tion or delay, and thus provide a superior service in such circumstances. (G) The volume of a particular farm commodity shipped from many areas is not large enough to encourage com­ mon carriers to make the investments in equipment and facilities adequate to serve farmers in the area. (H) The exemption assures that competition will provide an incentive for satisfactory service. Otherwise, in many situations, farmers would be dependent on one railroad or one truck line irrespective of the adequacy, effi­ ciency, or selectivity of its service. (I) Farmers often need a personalized service in which they can rely upon the driver to follow instructions concerning the manner in which such service is to be provided. Exempt carriers are usually local people, competing for business, who are generally reliable and responsible individuals. Common carriers cannot usu­ ally assure the same degree of personalized service as is commonly provided by exempt carriers. The ship­ pers' instructions do not necessarily filter down to the driver or drivers, particularly where interchange of equipment or responsibility is involved. The exemption provides a farmer-shipper with better control of his transportation than would be true in many cases if he turned his products over to a common carrier. This control is needed to meet market commitments and requirements.2 In commenting on the rate publication proposed for inland water carriers, the Farm Bureau said that "the service provided by inland water carriers is generally satisfactory, at reasonable rates,

85 and at satisfactory return to carriers." 3 They went on to say that the enactment of these proposals "would curtail competition by substituting 'one party' carrier rate determinations, for 'two party' competitively bargained rates between shippers and carriers." 4 In general, users of exempt carriers vigorously opposed the Surface Transportation Act, while carriers, including many exempt carriers, strongly supported it. As could be expected, carriers often supported it on the grounds that exempt carriage provides poorer service than regulated carriage, that rates tend to be stable with regulated carriage and may often go down, and that the financial stability of regulated carriage is higher than that for unregulated carriage. On the other hand, proponents of unregulated carriage, which include the users of it, generally claim exactly the opposite except for the financial stability of the carriers. Proponents of unregulated carriage assert that rates are lower and service is much better without ICC control. It is also possible that regulation could be strengthened in other ways besides those specified in the Surface Transportation Act. More power could be given to the ICC to control more aspects of transportation, although it is hard to identify any areas where the commission is now seriously hampered in carrying out its congres­ sional directives. Some argue that the commission should have more authority over financial matters to prevent the diversion of revenues from rails into other areas. Whether more power would permit the ICC to force railroads into investing in an uneconomic industry seems questionable. It seems likely that any additional regulatory authority would be exercised in the same manner the ICC administers existing regula­ tions. Thus, unless the congressional directive was significantly modified to encourage hard competition, the commission could be expected to continue to follow past policies. Even a congressional directive to foster competition might not be enough, as evidenced by the changes made in the 1958 act that instructed the commission not to hold up the rates of one carrier to protect the market of another. Yet, in the "Ingot Molds" and "Big John" cases, the ICC attempted to do just that.

Transportation Regulatory Modernization Act

The alternative is to move towards less or no regulation. For exam­ ple, the bill proposed by the Nixon administration in the fall of 1971, the Transportation Regulatory Modernization Act, recom­ mended a movement towards less regulation and more dependence

86 on competitive forces. The Department of Transportation (DOT) proposals, which included a separate financial aid bill, had a number of features similar to those in the industry bill. It provided loan guarantees for the purchase of freight cars; it provided expeditious handling of abandonments; and it restricted the right of states to tax transportation facilities more heavily than other types of prop­ erty. But the regulatory aspects were considerably different. The three controversial regulatory proposals offered by the Transporta­ tion Regulatory Modernization Act dealt with entry, rates, and antitrust immunity. The Regulatory Modernization Act would have added a new paragraph to the Interstate Commerce Act, 207 (b), that would have read as follows: No certificate shall be denied upon the grounds that its issuance would result in the diversion of traffic from any existing carrier, unless the Commission finds that granting such license would result in a diminution in the total quan­ tity and quality of service available to the public; except that, for a period of twenty four months following enact­ ment of this section, this subsection shall apply only with respect to an applicant which holds a certificate of public convenience and necessity issued by the Commis­ sion, and which is seeking to extend the rights accorded in such certificate. r> This change in wording would have prevented the commission from denying an application simply on the grounds that by diverting traffic it would adversely affect the profitability or viability of any other carrier. Although this proposal was very actively opposed by existing motor carriers and by the ICC, there was no need for them to feel threatened. As can be seen from Table 4 there were no applications for either de novo entry or extensions that were denied because traffic would be diverted from competing carriers. Denials were generally based either on the carrier being unfit or there being no sho\ving that the existing service was inadequate. Both categories for denying applications would have still remained in effect under this bill. It is clear that the administration's objective in making this proposal was to permit greater freedom of entry, but with this statutory language and the ICC's bias, it strikes this author that the provision would be inadequate to accomplish that aim. Of more significance was the proposed amendment to Section 208(a)-a sec­ tion which deals with ICC control over motor carrier services, routes,

87 and over the commodities which they may carry. This proposed amendment read: On and after the sixth month following the enactment of this Section the Commission shall not impose any term, condition, or limitation on any certificate or permit issued pursuant to Section 207, Section 209, Section 212, or Section 5 with respect to commodities carried, points served, equipment used, or routes used or otherwise, for the purpose of preventing diversion of traffic from an existing licensed carrier or carriers, unless it finds that absent such restric- tion or restrictions, there would be a diminution in the total

quantity and quality of service available to the public....Ii This proposal might have significantly opened up the possibility for existing carriers to extend their service in any profitable direction. Thus, while new entry from outside the industry would not have been greatly liberalized, competition within the industry would have been greatly facilitated and costs would have been reduced. Motor carriers could have significantly reduced the uneconomic empty miles fostered by the commodity and route restrictions. The second major innovative regulatory proposal called for a zone of reasonableness for prices. Under the proposal, any rate that fell between the lower limit of the variable cost of moving the commodity and an upper limit of 150 percent of fully allocated cost would have been per se legal unless the rate violated the long-and­ short-haul clause or was unjust, preferential, prejudicial, or unduly discriminatory. The upper limit of the zone would have been triggered only if the shipper could show that there was no alternative effective and competitive service by common or contract carrier of another mode. In such a case it would have been up to the chal­ lenged carrier to show evidence that his rate was below 150 percent of fully allocated costs. If a rate was challenged as being too low, the burden of proof-to show that the rate was below variable costs-would have been with the complainant rather than the carrier. The act provided for the Department of Transportation to pre­ scribe a new cost formula for estimating variable cost. If, however, we assume that out-of-pocket costs are an estimate of variable costs, then Table 7 indicates that out of a total of twenty-five cases, eleven were denied because rates did not cover out-of-pocket costs, while six were denied because rates were discriminatory. Only eight of those denied would be approved under the proposed standards. This would have been a step in the right direction, but it would not have

88 provided full flexibility of pricing. It is true that eleven of these cases did not cover the out-of-pocket costs as measured by the ICC formula, but it is unlikely that these rates were truly noncompensa­ tory. Except in predatory pricing situations, which does not seem to characterize any of these cases, it would be unprofitable for any carrier to offer a rate below marginal cost. This proposal would have been significant in providing railroads and motor carriers with greater flexibility in rate making. Under such a provision, carriers could have moved quickly to take advantage of special circumstances. They could have experimented with lower and higher rates to determine the most profitable level without fear of being locked into an unprofitable rate structure. And innovations that require lower rates would have been possible. If such a zone of reasonableness had been in effect in the past, it is clear that unit trains would have been introduced sooner and the "Big John" cars might have seen service five years earlier. Moreover, greater price flexibility would permit the railroads to offer a variety of services at different rates. It would be possible to offer premium service at high rates as well as slow service for less. Another provision of this legislation was to narrow the antitrust immunity granted under the Reed-Bulwinkle Act. The proposed section would have confined antitrust immunity to carriers negotiat­ ing joint rates and through routes. Only those carriers physically participating in the joint-line or inter-line movement could have entered into the negotiations. Rate bureau or joint protests of any rate established by independent action would have been subject to antitrust prosecution. Limiting the scope of the Reed-Bulwinkle Act would have facilitated more independent rate making and encouraged a more competitive environment. As has been pointed out above, the level of per diem rates has played a major role in creating a shortage of freight cars. The Regulatory Modernization Act would have transferred authority to establish per diem ra~es from the ICC to the secretary of transporta­ tion, but no new directive was prescribed for setting these rates. Transferring this control to DOT would have effectively resulted in establishing two regulatory bodies dealing with freight rates. Under this proposal, DOT would have had jurisdiction over the allowance to private car owners against freight rates while the com­ mission would have still had control over the freight rates proper. Thus, two agencies would have regulated freight rates, a rather inefficient arrangement. In conclusion, the Regulatory Modernization Act would have been a major improvement in transportation regulation, but it would

89 not have dealt with all the problems identified. It would have com­ pletely ignored freight forwarders. On the positive side, entry would have become somewhat freer in trucking, rate flexibility would have been greater, and many of the inefficiencies identified above would have been reduced if not completely eliminated.

Total Deregulation

Another alternative would be to go further and totally deregulate surface freight transportation. In the 1970s, is there any need for regulation? Let us consider the sectors of the transportation industry in the reverse order in which they were regulated, and ask the question: Is there any reason to regulate that service?

Freight Forwarders. Since it takes little capital to combine small ship.ments into larger units, entry costs should, in an unregulated market, be nominal, with the result that competition would be vigorous. There was never any suggestion of instability in rates or of service by freight forwarders prior to regulation. The freight forwarding business exists and thrives in Canada without any regu­ lation. The only justification ever given for regulating freight for­ warders was that they were conspiring with railroads to erode ICC approved railroad rates. Consequently, freight forwarders could be completely deregulated with no harm to the economy. Significant gains to small shippers from improved service and lower costs would undoubtedly result from the new competitive environment.

Water Carriers. With only a negligible portion of water carriers now subject to regulation, and without any evidence that there are economies of scale or instabilities in the unregulated portion of water carriage, there seems to be no justification for its regulation. Most of the industry operates as a purely competitive transportation indus­ try. As was pointed out above, water carriers were subjected to ICC jurisdiction to reduce the competitive pressures on the rates of rail­ roads and motor carriers.

Motor Carriers. In 1969, about 41 percent of the intercity ton-miles that moved by motor carriers was subject to economic regulation. Unregulated agricultural carriage is efficient, economical, and pro­ vides excellent service. There are no apparent economies of scale in trucking. There appears to be no logical reason why competition could not work in this industry to provide efficient, inexpensive transportation for all shippers.

90 Unregulated trucking exists in other parts of the world and offers low cost and efficient service. Several provinces in Canada do not effectively regulate motor carriers. Australia abolished motor carriage regulation in the early 1950s. Great Britain more recently abolished regulation of trucking. Each of these cases has demon­ strated that regulation is not necessary to ensure good service. In fact, unregulated carriage tends to be less expensive, more efficient, and to provide better service than regulated carriage. For example, Mr. Stuart Joy, testifying before a congressional committee on the effects of deregulation of motor transport in Australia and Great Britain, said concerning the British case: The end of regulation in 1968 has not met any chaotic burst of price warfare. As far as we can see, the quantity or the frequency of bankruptcies in the road haulage industry has not changed with the end of regulation. There has been a gradual increase in the operations of firms who were once operating as private carriers. They have gradually moved into the public field. That is, they are now carrying back loads in what were once empty hauls.' Referring to the Australian experience he said: By ... 1958 and 1959, there had ... been five years in which everyone would have predicted total chaos, but in fact the industry was fairly subdued. There were a number of fairly large firms that were providing nationwide comprehensive service. There was a much larger number of middle size firms providing special service on particular routes, and there was an even larger number of very small firms often just providing service between one particular provincial city and the nearest State capital city.8 Thus it appears that total deregulation of motor carriage is both feasible' and practical and would be highly beneficial.

Railroads. The monopoly power that railroads had in short-haul markets during the nineteenth century no longer exists because of truck competition. Any monopoly power remaining with the rail­ roads is limited to long-haul bulk commodity traffic. But such traffic by its very nature is inherently competitive. For example, a grain producer in the Middle West has the choice of sending his grain to the Gulf Coast, to the East Coast, or to the Great Lakes for export, or to numerous other regions for domestic consumption. As a conse­ quence, even though only one road might exist between the shipper

91 and a particular destination, the competition of other roads and other destinations is always potent. Bulk commodities tend to sell in highly competitive final mar­ kets. The receipts a farmer receives for a commodity such as wheat, grain, or corn depends upon the price at destination minus trans­ portation costs. Whenever a railroad raises transportation rates, the farmer receives a smaller net, but in the long run this discourages farmers from producing that commodity, with an inevitable loss in traffic to the carrier. With motor carriers ready to offer transporta­ tion even for long hauls if rail rates get too high, railroads have very limited power over the rates of bulk commodities. Even though the monopoly power of railroads is negligible in most markets, it is true that under complete deregulation the rail­ roads would tend to price lower to some fortunately situated shippers than to those who have fewer good alternatives. Where a shipper has a locational advantage, he will gain over his competitor. Never­ theless, regulation has not eliminated such discrimination today. Rates are less where railroads have water carrier competition than where they face none.9 Complete deregulation of railroads would not lead to the elimination of all discrimination but would likely reduce its magnitude and possibly shift its burden. It is often argued that without regulation the railroads would practice predatory pricing to eliminate competitors. It should be clear that it would be neither profitable nor possible for railroads to employ predatory prices against either motor carriers or water car­ riers. For either mode, entry of new carriers is too easy for the railroads to be able to establish a successful monopoly. On the other hand, one railroad could profitably use predatory prices against another railroad inasmuch as, even without regulation, there are large barriers to establishing a new rail carrier. Thus, if a railroad success­ fully drove out a competitor, it would be established in a long-run monopoly position. Total deregulation might for that reason result in some predatory pricing among railroads, but not by a railroad against another transportation mode. This type of predatory pricing is equally likely in any industry with substantial barriers to entry. Of course, predatory pricing is illegal under the antitrust laws-which appear to have been suffi­ cient to deter such policies. Canada, which permits greater flexibility in railroad pricing than does the U.S., has not been troubled with even allegations of predatory pricing. It seems logical to conclude that, even if regulations were done away with, predatory pricing would not be a problem.

92 In conclusion, the history of regulation clearly indicates that it was established mainly to reduce the competitiveness of railroads. Its objective almost from the beginning has been to maintain cartel pricing and to increase the profitability of railroads. In spite of the fact that it has not been very successful in recent years in securing profits for rail carriers, it has inflicted substantial costs and ineffi­ ciencies on the rest of the economy. The whole regulatory process, therefore, is inherently faulty in such a competitive sector of the economy as transportation. Antitrust regulation appears to be the only type of public control necessary. The abolition of all economic regulation of surface freight transportation would bring large benefits to shippers, consumers, and the economy.

93

NOTES

NOTES TO CHAPTER I

1 The following pages are largely based on Paul W. MacAvoy, The Economic Effects of Regulation (Cambridge, Massachusetts: MIT Press, 1965), and Gabriel Kolko, Railroads and Regulation, 1877-1916 (Princeton: Princeton University Press, 1965). 2 MacAvoy, Effects of Regulation, Table 3.2, p. 30. 3 Ibid., p. 41. 4 Kolko, Railroads, p. 7. lj Ibid., p. 8. 6 Ibid., p. 16. 7 Ibid., p. 17. 8 Ibid., p. 27. 9 Ibid., p. 28. 10 Ibid., p. 35 ] 1 Ibid., p. 37. ]2 Robert M. Spann and Edward W. Erickson, "The Economics of Railroad­ ing: The Beginning of Centralizing and Regulation," The Bell Journal of Econom­ ics and Management Science, Autumn 1970, pp. 104-111.

NOTES TO CHAPTER II

] Kolko, Railroads, p. 50. 2 MacAvoy, Effects of Regulation, p. 201. S Ibid., p. 127. 4 Ibid, pp. 144-153. lj Spann and Erickson, "Economics of Railroading," p. 242. G Interstate Commerce Commission v. Alabama Midland Railway Company, 168 U.S. 144 (1897), pp. 171-172. 7 Data on capital values and rates of return are very poor for this period and no conclusions on profit rates are justified. S Academy of Political Science, New York Proceedings, Railroad Legislation, vol. 8, no. 4 (New York, 1919), p. 562. 9 Ibid., p. 614. 10 41 Stat. 488. 11 48 Stat. 220.

NOTES TO CHAPTER III

1 For a complete history of the origins of motor carrier regulations, see James C. Nelson, "The Motor Carrier Act of 1935," Journal of Political Economy, August 1936. 249 U.S.C., sec. 308(a).

95 :~ 49 U.S.C., sec. 307(a). 4 Board of Investigation and Research, Federal Regulatory Restrictions Upon Motor and Water Carriers, Senate Document 78, 79th Congress, 1st session, 1945. :J U.S. Congress, Senate, Com.mittee on Commerce, Special Study Group on Transportation Policies in the United States, National Transportation Policy Report, U.S. Senate Report No. 445, 87th Congress, 1st session, 1963. fi 49 U.S.C., sec. 304(a) (1). 7 49 U.S.C., sec. 303(a)(15). R 49 U.S.C., sec. 309(b). n 49 U.S.C., sec. 903(e)(2). 10 Freight Forwarder Investigation, 229 I.C.C. 201 (1938). ] 1 Ibid., 289. ] 2 Ibid., 304. ]349 U.S.C., sec. 1010(c). 14 56 Stat. 291. 15 The new paragraph now reads, in part (new phrasing italicized); "... made under this section by a corporation controlled by, or under common control with, a common carrier subject to Chapter 1 of this Act [railroads] solely on the grounds...." 49 U.S.C., sec. 1010(d). 1f) 54 Stat. 899. ] 7 The Interstate Commerce Commission defines "fully allocated cost" to include all costs connected with the movement of the product plus some alloca­ tion of the overhead. The concept therefore is an attempt to reflect average cost, but since the allocation of the overhead can only be arbitrarily assigned, the cost item itself is arbitrary. 18 49 U.S.C., sec. 15(a)(2). ] n See George Hilton, The Transportation Act of 1958 (Bloomington: Indiana University Press, 1969) for a discussion of ILgislative efforts to deal with umbrella rate making. 20 324 U.S. 443. 21 49 U.S.C., sec. 15(a)(3).

NOTES TO CHAPTER IV

1 1 M.C.C. 190, 203. 2 84 M.C.C. 157, 162. 3 110 M.C.C. 180, 184-185. 4 Interstate Commerce Commission, Annual Report, 1971, p. 85. ;j These cases sometimes included more than one application from a firm or included the applications of several firms. It was not practically possible to consider each application nor, since many were overlapping, would it have been meaningful. () Carriers are divided into classes according to their annual receipts with Class A or Class I carriers being the largest and in total carrying most of the traffic. • 7 110 M.C.C. 266, 268. 8 108 M.C.C. 245, 253. n 111 M.C.C. 575. 10 Ibid., 597, 598. ] 1 337 I.C.C. 111, 112. ]2 Ibid. ]3 Ibid., 118-119. 14 Section 15(a) of the Interstate Commerce Act (49 U.S.C. 15(a)(2)) directs the commission in prescribing rates for all modes to consider the need for "efficient railway transportation" but says nothing about efficient transportation by other

96 modes. Section 15 (49 U.S.C. 15(1)) authorizes the commission to prescribe rates whenever it finds that they are or will be "unjust or unreasonable or unjustly discriminating or unduly preferential or prejudicial. ..." 1;' See the next chapter for a discussion of economies of scale in railroading. IH 326 I.C.C. 77. 17 392 U.S. 571. 18 335 I.C.C. 111. 10 337 I.C.C. 287. :!O Interstate Commerce Commission, Annual Report, 1971, p. 25. 21 340 I.C.C. 868, 889. 22 E. V. Mosback, Economic Analysis of Per Diem Rates of Freight Cars (Washington, D. C.: Jack Faucett Associates ·for Department of Transportation, January 1971). (See U.S. Congress, Senate, Committee on Commerce, Subcom­ mittee on Special Freight Car Shortages, Freight Car Shortages, 92nd Congress, 1st session, 1972, pp. 951-1054.) 2:~ William H. Van Slyke, executive director of the Association of American Railroads' Car Service Division as quoted in the AAR Information Letter, no. 2029, August 2, 1972, p. 3. 2-t 111 M.C.C. 151. 25 Ibid., pp. 186-187. 20 U.S. Congress, House, Committee on Interstate and Foreign Commerce, Subcommittee on Transportation and Aeronautics, Hearings on Transportation Act of 1972, 92nd Congress, 2nd session, 1972, p. 593 (hereinafter cited as House Transportation Hearings). 27 U.S. Department of Agriculture, Interstate Trucking of Frozen Fruits and Vegetables Under Agricultural Exemption, Marketing Research Report No. 316, 1959. 2H 111 M.C.C. 427. 20 337 I.C.C. 430. :w 49 U.S.C., sec. 5(2)(c). 31 See, for example, United States v. Interstate Commerce Commission, 396 U.S. 491. 32 Lawrence R. Klein, A Textbook of Econometrics (Evanston, Illinois: Row Peterson & Co., 1953), pp. 226-236. a:~ G. H. Borts, "The Estimation of Rail Cost Functions," Econometrica, January 1960. 3-t Zvi Griliches, "Notes on Railroad Cost Studies," Report No. 6918 (Univer­ sity of Chicago: Center for Mathematical Studies on Business and Economics, 1969), p. 30. 35 Ann F. Friedlaender, "The Social Cost of Regulating Railroads," American Economic Review (May 1971), p. 233, and Thomas G. Moore, "The Feasibility of Deregulating Surface Freight Transportation," in Competitive Policy and Regu­ lated Industries, ed. Almarin Phillips (Washington, D. C.: The Brookings Institu­ tion, 1972), forthcoming, p. 47. 3(; Department of Transportation, Western Railroad Merger, Staff Study by the Office of the Assistant Secretary for Policy Development and the Federal Railroad Administration, January 1969. 37 Robert E. Gallamore, "Railroad Mergers: Cost, Competition, and the Future Organization of the American Railroad Industry" (Ph.D. dissertation, Harvard University, 1968). 3H U.S. Congress, Senate, Committee on Commerce, The American Railroads: Posture, Problems, and Prospects, Staff Analysis for the U.S. Senate Committee, 92nd Congress, 2nd session, August 28, 1972, p. 7. 3D Ibid., p. 76. -to 57 M.C.C. 341 (1950).

97 NOTES TO CHAPTER V

1 U.S. Department of Agriculture, Interstate Trucking, report no. 316. 2 U.S. Department of Agriculture, Interstate Trucking of Fresh and Frozen Poultry under Agricultural Exemption, Marketing Research Report No. 224, 1958. :3 James Sloss, "Regulation of Motor Freight Transportation: A Quantitative Evaluation of Policy," The Bell Journal of Economics and Management Science, Autumn 1970, p. 351. o! Josephine E. Olson, "Price Discrimination by Regulated Motor Carriers," American Economic Review, June 1972. [) Freight Forwarder Investigation, 229 I.C.C. 201 (1938). 6 Karl M. Ruppenthal, "Some Economic Aspects of the Barge Line Mixing Rule," Transportation Journal, vol. 9, no. 3 (Spring 1970), pp. 5-43. 7 113 M.C.C. 225, pp. 226-227. 8 Ibid., p. 227. 9 House Transportation Hearings, pp. 1365-1366. ]0 318 I.C.C. 641; 321 I.C.C. 582; 325 I.C.C. 752. ] 1 Paul W. MacAvoy and James Sloss, Regulation of Transport Innovation (New York: Random House, 1967). ]2 Robert W. Harbeson, "Toward Better Resource Allocation in Transport," The Journal of Law & Economics, October 1969, p. 334. 1:~ John A. Meyer, Morton J. Peck, John Stenason, and Charles Zwick, The Economics of Competition in the Transportation Industries (Cambridge, Massa­ chusetts: Harvard University Press, 1960), p. 165. ]o! Interstate Commerce Commission, Transport Economics, monthly com- ment by the Bureau of Economics, May 1971. If) Moore, "Deregulating Surface Freight Transportation." 16 Friedlaender, "Social Cost of Regulating Railroads," pp. 226-234. 17 Ruppenthal, Barge Line Mixing Rule, pp. 5-43. ] R Morton J. Peck, "Competitive Policy for Transportation?" in Perspectives on Antitrust Policy, ed. Almarin Phillips (Princeton: Princeton University Press, 1965), pp. 244-272. 19 Harbeson, "Resource Allocation in Transport," p. 334. 20 Ann F. Friedlaender, The Dilemma of Freight Transport Regulation (Washington, D. C.: The Brookings Institution, 1969), p. 65.

NOTES TO CHAPTER VI

1 See Transportation Legislation, Legislative Analysis No. 22 (Washington, D. C.: American Enterprise Institute, 1972) for a discussion of these proposals. (This analysis covers developments in Congress pertaining to these proposals through the 1972 committee hearings.) 2 Supplementary Statement of the American Farm Bureau Federation to the Surface Trqnsportation Subcommittee of the Senate Committee on Interstate and Foreign Commerce (Transportation bills, S. 2362, S. 2541 and S. 2842), March 15, 1972. 3 House Transportation Hearings, p. 482. 4 Ibid., p. 483. [) The Transportation Regulatory Modernization Act of 1971 (H.R. 11826; S. 2842). 6 Ibid. 7 House Transportation Hearings, p. 1388. 8 Ibid., p. 1386. 9 For a discussion of this, see Moore, "Deregulating Surface Freight Trans­ portation"; for some evidence on this point, see Friedlaender, Dilemma, pp. 61-63.

98 The American Enterprise Institute for Public Policy Research, established in 1943, is a publicly supported, nonpartisan, research and educational organization. Its purpose is to assist policy makers, scholars, businessmen, the press, and the public by providing objective analysis of national and international issues. Views expressed in the institute's publications are those of the authors and do not neces­ sarily reflect the views of the staff, advisory panels, officers, or trustees of AEI.

Council of Academic Advisers Paul W. McCracken, Chairman, Edmund Ezra Day University Professor of Busi­ ness Administration, University of Michigan Kenneth W. Dam, Harold I. and Marion F. Green Professor of Law, University of Chicago Law School Milton Friedman, Senior Research Fellow, The Hoover Institution on War, Revo­ lution and Peace; Nobel Laureate in Economic Science Donald C. Hellmann, Professor of Political Science and International Studies, University of Washington D. Gale Johnson, Eliakim Hastings Moore Distinguished Service Professor of Economics and Provost, University of Chicago Robert A. Nisbet, Resident Scholar, American Enterprise Institute Marina v. N. Whitman, Distinguished Public Service Professor of Economics, Uni­ versity of Pittsburgh James Q. Wilson, Henry Lee Shattuck Professor of Government, Harvard University

Executive Committee Herman J. Schmidt, Chairman of the Board Richard J. FarreIl William J. Baroody, Jr., President Richard B. Madden Charles T. Fisher III, Treasurer Richard D. Wood

Gary L. Jones, Vice President, Edward Styles, Director of Administration Publications

Program Directors Periodicals Russell Chapin, Legislative Analyses AEI Economist, Herbert Stein, Editor Robert A. Goldwin, Seminar Programs AEI Foreign Policy and Defense Robert B. Helms, Health Policy Studies Review, Robert J. Pranger and Donald C. Hellmann, Thomas F. Johnson, Economic Policy Studies Co-Editors Marvin H. Kosters/James C. Miller III, Public Opinion, Seymour Martin Government Regulation Studies Lipset, Ben J. Wattenberg, Co­ Editors; David R. Gergen, Jack Meyer, Special Projects (acting) Managing Editor W. S. Moore, Legal Policy Studies Regulation, Antonin Scalia and Murray L. Weidenbaum, Rudolph G. Penner, Tax Policy Studies Co-Editors; Anne Brunsdale, Howard R. Penniman/Austin Ranney, Managing Editor Political and Social Processes William J. Baroody, Sr., Robert J. Pranger, Foreign and Defense Counsellor and Chairman, Policy Studies Development Committee SELECTED AEI PUBLICATIONS Regulation: The AEI Journal on Government and Society, published bi­ monthly (one year, $12; two years, $22; single copy, $2.50) Regulation and. Regulatory Reform: A Survey of Proposals of the 95th Con­ gress (59 pp., $2.00) Major Regulatory Initiatives during 1978: The Agencies, the Courts, and the .Congress (26pp., $2.00) Advertising, Prices, and Consumer Reaction: A Dynamic Analysis, John M. Scheidell (71 pp., $2.75) A Conversation with the Honorable Barry Bosworth: Coping with Inflation (26 pp., $2.25) Ford Administration.Papers on Regulatory Reform, Paul W. MacAvoy, ed. Federal Milk Marketing Orders and Price Supports (168 pp., $3.75) Railroad Revitalization and Regulatory Reform (246 pp., $4.75) Regulation ofEntry and Pricing in Truck Transportation (301 pp., $5.75) Regulation of Passenger Fares and Competition among the Airlines (210 pp., $4.75) Deregulation of Cable Television (169 pp., $3.75) Federal-State Regulation of the Pricing and Marketing of Insurance (105 pp., $3.25) Federal Energy Administration (195 pp., $3.75) OSHA Safety Regulation (104pp., $3.25)

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