Railroads: Rates and Regulations

by William Zebina Ripley

Cost of service, while unsound as a sole reliance, nevertheless affords an important check upon the value of service principle. Without it there is always grave danger that traffic managers, seeking to enlarge their revenues, may push rates unreasonably high. At first sight it would appear as if this could not occur, inasmuch as an inordinately high rate would immediately reduce the volume of business offered. It is constantly alleged by railway men that this must of necessity occur. And it would indeed follow, were it not that the incidence of the rate is rarely upon the actual shipper. He merely pays it, and at once shifts it to the consumer. For low-grade or staple goods like cement or kerosene, where transportation charges form a large part of the total cost of production, it is conceivable that higher freight rates might so far increase the price as to check consumption. Five cents a hundredweight higher freight means $1.25 per 1,000 ft. added to the price of soft lumber, $2 to hard lumber; three cents per bushel added to the price of wheat, and $1 to the ton of pig iron or coal. Such substantial additions might readily reduce the demand. Yet even this would not be true of necessities of life like anthracite coal or sugar, on which latter the freight rate amounts to about one-half cent per pound. Is five cents a barrel added to the price of flour likely to decrease the consumption of that staple commodity? Yet the enhancement of railway revenues would indeed be enormous from such an increase of freight rates. For these necessities of life, an increased freight rate might become an actual charge upon the people, without reducing their consumption, like a tax upon salt. Only upon goods the use of which might be freely lessened, would higher freight rates be reflected in a corresponding decline in the volume of business. Moreover, with all high grade traffic, the value of service principle fails utterly by itself alone to prescribe the upper level of a reasonable charge. Competent testimony is ample upon this point. Thus from the commissioner of the Trunk Line Association;[143] "The tonnage of the higher class articles is an extremely difficult matter for transportation companies to increase or decrease.... In that class of articles the carrier can do but little to increase the transportation." And the reason in part lies in the almost immediate diffusion of the burden in the processes of distribution. That no complaints are made—a defence often brought forward for higher rates—proves by itself the uncertain incidence of the burden imposed.

That the principle of charging what the traffic will bear affords no protection to the consumer against exorbitant rates on many commodities, follows also from the relative insignificance of transportation charges as compared with the value of the goods. This, in fact, is naively conceded by railway managers themselves; when, as in the case of the widespread freight rate advances of 1908-1909, publicity agents flooded the country with calculations as to the infinitesimal fraction which would be added to the price of commodities by a ten per cent, rise in rates.[144] The rate from Grand Rapids to Chicago on an ordinary dining room set of furniture, being $1.60, a ten per cent. increase would add only sixteen cents to the cost. A harvester transported one hundred miles would be enhanced seventeen and a half cents in price; a kitchen stove carried from Detroit to the Mississippi would only cost twenty-five cents more; and the price of a Michigan refrigerator sold in New York, would be only seven and one-half cents higher; were freight rates to be increased by ten per cent, in each instance. On wearing apparel the proportions were represented as even more striking. An ordinary suit of clothes transported three hundred miles, under similarly enhanced rates, would, it was alleged, cost only one-third of a cent more. For all their apparel, made in New England, consisting of everything from hats to shoes, each wearer in the Middle West would be affected by a ten per cent. rise of rates by less than one cent apiece. True enough all this; and a striking testimonial to the effectiveness of the railway service of the country! But at the same time, if a ten per cent. increase of rates is inappreciable to the consumer, why not increase them by twenty per cent.[145]

And what becomes of the argument that charging rates according to what the traffic will bear, is an ample safeguard against extortion? Many of these small changes in price are diffused in the friction of retail trade;[146] some of them are unfortunately magnified to the consumer, especially under conditions of monopoly. When freight rates on beef go up ten cents per hundredweight, the consumers' price is more likely than not to rise by ten times that amount. But even assuming the final cost to follow the range of transportation charges closely, is it not evident that, so small relatively are many freight charges by comparison with other costs of production, that consumption is not proportionately affected by their movement one way or the other? And yet the entire argument that the value of service principle is a self-governing engine against unreasonable rates, is based upon this assumption. Surely the increased income to the carriers when rates are raised must come from someone. Because it is not felt, is no reason for denying its existence as a tax. But the very fact that it is not felt, undermines the argument that a safeguard against extortion obtains. The theorem that value of service in itself affords a reliable basis for rate making, pre-supposes that freight rates and prices move in unison; a supposition which a moment's consideration shows to be untenable in fact.[147] Such cases must be finally settled by some reference, indefinite though it be, to the cost of conducting that particular service; or rather, as Lorenz puts it, to the extra cost incident to that service. This extra cost may oftentimes be segregated, where the total cost could not be ascertained.[148]

That the problem is, however, a most difficult one is evidenced by the periodic controversies over railway mail pay.[149]

Of course in order that any change of rates should be reflected in prices, all carriers must of necessity agree upon the matter. The price is made by the least expensive source of supply. So that any carrier refusing to raise rates, might aid in the continuance of an already established price. Under conditions of transportation prevalent in the United States twenty years ago, the likelihood of an increased freight rate becoming a tax upon the community, was lessened by the probability that either by means of secret rebates, or by special and perhaps open commodity rates, some roads might choose to protect their clients against enhancement of prices. Markets were local—not reached by great systems operating from remote sources of supply. The policy of the northern transcontinental lines in making lumber rates from Oregon to the Middle West, might be quite independent of any policy in force on the southern hard pine carrying roads. But under present day conditions, the entire area of the United States is one great market. Hence, with rebates eliminated and with practical monopoly established through actual consolidation, control or harmony of policy, the carriers have the consumers much more completely at their mercy. Only two safeguards for the public interest remain. One is government regulation, or at all events supervision, of charges. The other is "enlightened self-interest"—which in transportation matters means a full appreciation of the possibilities and limitations in the application of the value of service principle to the determination of rates.

Considerations of cost of service afford protection, not only against unreasonably high rates, but also against unduly low charges. The evil in such cases is not only that the carriers operate at a loss, but that inequality and discrimination are inevitable concomitants of too low rates. No railway conceivably, of course, will charge unremunerative rates for a long time. But it sometimes happens that managements may be led to the adoption of policies of temporary expediency, not compatible with the long-time welfare of stockholders. During the presidency of Charles Francis Adams on the Northern Pacific in 1890 an unaccountable and unnatural diversion of traffic from this road to the Atchison, Topeka & Santa Fe suddenly occurred.[150] A large volume of freight from the East to Oregon was diverted to the roundabout route via Southern California. On investigation it appeared that the English banking house of Baring Brothers, having become involved in unfortunate Argentine speculation, and being obliged to force a market for its investments in Atchison securities, demanded an immediate showing of large gross earnings regardless of the net profits. Orders to get traffic at any price went forth. A market was made for Atchison stock; although it was powerless to prevent the firm's final bankruptcy. In such a case the only safeguard against unreasonably depressed rates by the Atchison road, which, of course, immediately compelled corresponding reductions by the natural routes to the Northwest, should have been consideration of the actual cost of moving traffic by so long and roundabout a route. And yet this consideration was entirely ignored. Another illustration of the same danger occurred in April, 1903.[151] A gang of western speculators unobtrusively acquired control of the Louisville & Nashville road, by taking advantage of the issue by that company of a large amount of new stock. This they did by the use of borrowed money. They had no intention, even had they been sufficiently well financed to do so, of permanently controlling the road as an investment. They bought the stock merely in order to resell it at a higher figure. They threatened the railway world with a general disturbance of rate conditions throughout the South. Their plan was to cut rates and steal traffic from other roads in order to make a large show of gross earnings; and to unload their stock holdings on the market thus made, before the public learned the truth. This was prevented only by repurchase of their stock at very high prices. In such a case, what guidance would the principle of charging what the traffic would bear, afford? Cost of service must be invoked in order to determine the reasonableness of the low rates in force.

In any industry where rates are made under conditions of monopoly rather than of free competition, it is imperative that cost of service be constantly held in view. Under conditions of free competition it is bound to obtrude itself automatically; but under monopoly it must oftentimes be forcibly invoked. The shipper whose manufacturing plant has once been located in a certain place is no longer free to accept or reject a certain rate. He can afford neither to move nor to abandon his works. In order to continue in business he must meet the prices made by competitors. This price may be made elsewhere under more favored circumstances. To a manufacturer an increase of freight rates instead of curtailing output, may lead to attempts to lessen the costs of production per unit by an enlarged output sold at cut prices. Under such conditions an enhanced freight rate is a positive deduction from profits without any gain to the consumer. It is impossible to trace any safeguard against extortion in the operations of a value of service law under such circumstances. An instance in point is afforded by a complaint of the Detroit Chemical works in 1908.[152] This company imported iron pyrites through Baltimore from Spain; that being the source of the bulk of the material used here in the manufacture of sulphuric acid. The Detroit Company sold its product throughout the West in competition with companies at St. Louis, Chicago and Buffalo. The companies at Chicago and St. Louis enjoyed low import rates by way of the Gulf ports. The Buffalo concern used to be favored by a low rate said to be due to canal competition on shipments from New York. Since 1903, however, the rate on pyrites from Baltimore to Detroit had been steadily increasing, from $1.56 to $2.72 per long ton. Even this latter rate by itself does not seem absolutely excessive, yielding a revenue of less than four mills per ton mile. But here again, it was not the absolute but the relative rate upon which the continued welfare of the industrial concern depended. The question had to be decided, not on the basis of cost, but from the point of view of the value of the service to the user. The carriers after this petition was filed voluntarily reduced the rate fifty-one cents per ton in January, 1908. The relative rate as compared with that to other competitive points was thus more equitably adjusted. The Interstate Commerce Commission on a review of the evidence held that this increase to $2.72 was unreasonable and unjust so long as it had been in effect; and awarded reparation to the amount of fifty-one cents per ton on all shipments made during its continuance.

It is indisputable that the great dynamic force in railway operation inheres in the value of service idea. The traffic manager who is always considering how much it will cost to handle business, will seldom adventure into new territory. The United States, as a rapidly growing country, is consequently the field in which charging what the traffic will bear, has been most ardently upheld as the only practicable basis for rate making. A few detailed illustrations will serve to show the results of its application in practice. Not infrequently does it happen that rates are different over the same line for shipments between two given points in opposite directions. Where this is due to a preponderance of traffic in one direction, and a consequent movement of "empties" which invite a back loading at very low rates, the difference of charges according to direction may actually be due to differences in the cost of carriage.[153] An empty train, which must be returned from New York to Chicago for another loading of grain, or to Georgia or Oregon for shipments of lumber, if loaded with merchandise, can be moved with no allowance for dead weight of cars or locomotives; inasmuch as the train must move in any event, whether loaded or empty. But even where this defence of difference in the cost of service fails, the practice may be entirely proper from every point of view. By increasing the total tonnage a special rate may ultimately contribute to lower charges all along the line. Raisin culture began in California in 1876. Prior to that time the Spanish product had supplied the American market. The first thing to do was to find a market for the California raisins in the East. They would not bear the freight rate which had previously been charged for Spanish raisins moving over the transcontinental lines westward. A very low rate was all that the new traffic would bear. During the year 1876 therefore 70,000 lbs. of California raisins were carried east at one and three-fourths cents per 100 lbs., while simultaneously 1,000,000 lbs. of Spanish raisins were carried west over the same lines at a rate of three cents. No such difference in the cost of service in opposite directions existed, although a preponderance of empties moving eastward undoubtedly cheapened the service from California. The aim of the commodity rate was to upbuild a new industry. How far this succeeded appears from the fact that in 1891, no Spanish raisins were carried west at all; while the eastbound shipments amounted to 37,600,000 lbs.[154] The preceding illustration leads us then to this further conclusion. The cost of service principle might most conceivably be applied to a railway in a purely static state. But, dynamically considered, as involving the growth and development of business, it fails utterly by itself to meet the necessities of the case.