Essentials of Economic Theory / As Applied to Modern Problems of Industry and Public Policy

by John Bates Clark

When, in the Interest of General Productivity, a Reduction of Local Charges is called for.—We saw that carriers of a primitive kind competing with each other would put every charge, local or otherwise, on a basis of its proportionate share of total costs. The traffic as a whole would return enough to cover all the outlays, and each part of it would yield its share. This is the ideal of effectiveness for railroads, as well as for ships and wagons. The attainment of the ideal without a regulation of charges by the state is never to be expected. One feature of this normal condition is that, where no special improvements have recently been made, total returns should just equal total costs, in the sense in which terms are used in static theory—that sense in which all interest charges and all expenses of management figure among the costs. No net profit for the entrepreneur, but full interest for the capitalist and full wages for all varieties of labor, is the rule that gives the static measure of normal returns. If a state shall slowly reduce the charges for local freight, while holding unchanged those for through traffic,—all the while allowing the total returns of the railroads to cover what we have defined as total costs,—it will do all it can toward securing an approximation to the condition which affords the largest product of social industry. It will help to make the resources of the people do their utmost in yielding an income. Total returns covering all costs, a reduction of those charges on local traffic which have prevented industries from springing up at intermediate points between favored centers, a gradual increase of local production without any positive repression of production elsewhere—such are some features of the general change which the future should bring and which only the power of the state can make it bring.

How the State may secure what Competition secures in Other Fields.—In general industry the rivalry of entrepreneurs carries prices to a level fixed by costs, but in transportation the rivalry has so largely disappeared as to prevent such an outcome. The state cannot restore much of the vanished rivalry and would cause an unnatural condition if it did so. We have seen toward what an abnormal level of costs a sharp "freight war" carries rates. What the state can do is something which an instinctive judgment of the people is impelling it to do; namely, to adjust rates directly and bring them gradually toward the standard to which competition, if it were working as it elsewhere works, would automatically bring them, namely, that at which wages and interest are fully covered. A surplus above these outlays could always be temporarily secured wherever a special economy had been effected, and the source of legitimate profit would be open to carriers as it is to producers generally. How much should be reckoned as interest depends on the question how the capital itself is estimated, and here again the instinct of the people has been correct. It will not accept as a measure of true capital the market value of all the stocks and bonds the railroad has issued. The quotations of the market make the total values of the stocks and bonds equal a capitalization of its total earnings, and these may include a profit due to monopoly. If a state were to figure the capital in this way, and then so adjust rates as to allow ordinary interest on the sum thus computed, it would merely leave total returns as they are. It might change comparative charges, but not the sum total of all of them.

How Capital should be Estimated.—In that static condition in which, as we have shown, capital is as productive in one subgroup as in another, the capital is first measured by the cost of the goods that, in the inception of the industry, embody it, and in static studies this cost is regarded as constant. Returns from different outlays are equalized, and a dollar invested in one kind of business then yields as much in a year as a dollar in any other. In a dynamic state the cost standard still prevails, and as the tools of production become cheaper, in terms of labor, it takes more of them to represent the same amount of capital that was originally invested. What it would at any time cost to duplicate every item in the equipment of a business measures the capital it uses. Nothing but a failure of competition in the case of railroads prevents the application of this standard to them. Monopoly makes earnings more or less independent of sums invested and causes purchasers to buy stock at rates that are independent of costs of plant and equipment and are fixed by earnings themselves.

The Process of Estimating Capital on the Basis of Cost.—If we undertake here to do by public authority what competition elsewhere tends to do, we shall have to restore the standard based, not on the original cost of the railroad's substantial property, but on the cost of getting another that would be equal to it in working efficiency. The plant is worth what it would naturally cost to duplicate it; and an average rate of interest on that sum is the natural return from it. There are ethical claims which are entitled to respect and which preclude any sudden reduction of the value of a railroad's properties; and, moreover, the end in view can be attained in a way that will not necessarily take anything from the absolute amount which they are now worth. If the amount of dividends remains fixed, the increase in the actual value of the plant itself will bring these dividends into the proper ratio to it. The land that the companies use is becoming more valuable. Measured by what it would cost to duplicate it, it represents a larger and larger amount on the companies' inventories. If the equipment also is enlarged as traffic grows, the entire sum on which interest and dividends are computed becomes continually larger. If the interest and dividends earned by the plants now in existence remain fixed in absolute amount, they will become a smaller and smaller percentage of the real capital of the companies. Merely letting railroads earn the amount that they do at present would bring the net incomes after some years to the same rate—the same percentage of invested capital—that the income from other capital represents. New plants and enlargements of old ones should be allowed to earn enough to furnish an incentive for providing them as fast as the needs of the public require it.

How Insuring a Fixed Amount of Total Earnings would affect the Rates charged for Freight.—It goes without saying that the general increase of traffic, while the freight charges remain the same, increases the net earnings of the carrying companies. Therefore the policy of keeping the net earnings at a fixed total amount would mean a reduction of rates for freight and passenger service. We do not here raise the question how much reduction will be required for the purpose in view—that of transferring to the people at large whatever now constitutes a genuine monopoly profit. In the case of some lines there is, it is safe to say, no such profit, and it will be impossible to tell how much of it elsewhere exists till some careful appraisal of plants and equipments, on the basis of the cost of duplicating them, shall have been made. What we need to know is that, by the aid of such an appraisal, the state can, if it will, secure in the department of carrying the result which is automatically secured elsewhere, namely, the prevalence of charges which afford normal returns on invested capital as well as wages for every kind of labor.

Elements of the Problem not included in a merely Economic Study.—It will not fail to occur to any reader that in making the present study of railroads a very general and purely economic one we leave out of account some facts of great importance. We take no account of corruption within the corporations which do the carrying, nor of corruption in the relation between them and the officials of the state. Stockholders within the corporation are likely to have their interests betrayed by those who are appointed to take charge of them, and citizens of the state are likely to have their greater interests betrayed, in a like manner, by their appointed custodians. We cannot here discuss the various plans by which directors plunder their own corporations, nor the ways in which public officials betray the people. All of these abuses are disturbing influences in the economic system; and all of them interfere with the adjustment which gives the highest productive efficiency, and contribute a full share toward putting the social order in danger. All are, however, so obviously criminal, if they are judged by the spirit of the law,—not to say by the letter of it,—that it is better to leave the discussion of the mode of suppressing them to legal and political science.

A Practical Mode of Insuring an Approach to Normal Rates for Transportation.—When competition rules, it enlarges the supply of a dear article till the price of it is normal, and it increases the capital in a profitable business till its earnings become so. In the case of railroads this does not automatically take place, but the result of it all—adequate service and normal charges for it—can be directly secured by the state. Charges that have been made reasonable by competition may be left as they are, and those that are disproportionately high may be gradually lowered. The growth of traffic may be trusted to keep the total earnings of the companies' present plants at the amount at which they now stand, in spite of these reductions of rates; and enlargements of the plants may be permitted to earn further sums which will attract capital and keep the service abreast of the public need. All this will require expert skill of a very high order. For the purpose of the present work it is enough to say that such a course as this is the only one which will insure in transportation the results which competition elsewhere yields. It will secure both rates and service which the civil law calls "reasonable" and economic law calls "natural."

FOOTNOTES

[1] If we wish to vary our supposition that the cost of making the goods at A and at C is the same, we have a modification of the case we have stated. If it is much cheaper to make them at A, the railroad that carries these goods from there to B may charge more for carrying than does the one that delivers the goods made at C. It is possible that the difference between the costs of making at the different points may tell decisively in favor of the longer route, and it may be the railroad from C to B that first reaches, in its charges, the level of variable costs and sees its traffic handed over to its rival.

[2] If carriers by water are in that intermediate state in which their capacity is only partially used, they also may offer to take some traffic for an amount which only covers variable costs; but this condition does not naturally become in their case semipermanent, as it does in the case of railroads.