In this issue, REASON presents a discussion of regulation in the transportation industry. Two industry spokesmen offer their arguments for regulation and government interference; the third participant, an economist, is alone in offering suggestions for free market solutions to the intricate problems of routes, schedules, pricing, etc. that face the huge industry. We think the contrast of the views given here is illuminating. The "ins" want to stay in, keeping competition out by means of their I.C.C., and the public be damned.
This discussion was presented before the Transportation Section of the Town Hall Forum in Los Angeles and is printed here by permission.
Joseph C. Kaspar, Director Division of Transportation Economics California Trucking Association
Frederick G. Pfrommer, General Attorney Atchison, Topeka and Santa Fe Railway Company
George W. Hilton, Professor of Economics University of California, Los Angeles
Remarks by: Mr. Joseph C. Kasper California Trucking Association
We have a situation in land transportation where the railroads were the dominant form of transportation. Trucks came along later getting an impetus from the military development during World War 1. In the 30s they began to make their mark to the point of becoming competitive. In 1935 they were brought under regulation.
Starting from nothing, the common carrier trucking industry in the United States now earns over half of all the revenues paid for land transportation. In California, we now earn up to 95% of all the intrastate revenues, so we can't say that regulation has had any adverse effect on our growth. Neither do we believe that a case can be made that the public has not enjoyed the type of service that they felt was necessary and desirable.
Why is there so much current discussion and pressure from some quarters to return to the laissez faire system insofar as transportation is concerned, where in every other field the government is taking over? The rest of the economic system is subject to increasing surveillance and control by the government, much of which is sought by various economic entities, not just by the bureaucrats. Regulation of transportation is a development which occurred before we started thinking about the more complete economic control we now have. Today the government is in everything, the price of a haircut, how much cotton you can grow, etc. Before any of that came into existence we had transportation regulated by the government. The reason is that it is almost as much of a utility as the availability of water or power. There was a necessity for some regulation to prevent various practices which could substantially disadvantage certain interests in the country.
The argument is being advanced that time and circumstances have changed and therefore regulation is outdated and no longer necessary. Many of these allegations are being made by people who had no voice in the type of regulation which has been established and they would like to have a crack at it.
It is fairly obvious that we have certain bureaucracies in government which would like to get rid of the present agencies so that they can step back in later when everyone says there is a problem and achieve goals which can't be achieved politically at the moment.
If you look at the subject from another angle, you would have to admit that times have changed, but no basic laws of economics have been repealed since transportation became regulated. And I doubt that there have been any changes in the laws which govern human nature and the advantages which some parties will take at the expense of others or at the expense of society as a whole. We, therefore, do not see that a change is necessary at this time which would remove the regulations which have served to stabilize the transportation system in this country.
Probably the regulated carriers have done a lot to bring this present wave of discussion upon themselves. The railroads perhaps have been more at the crying wall than we have, but that is understandable from my opening comments.
However, again it's human nature to blame any problems of management or circumstances on the regulatory agency, rather than to admit that it was your own mistake or that it was caused by forces greater than any of us. We feel that perhaps it is appropriate that we refuse a regulatory system which applies to transportation, but not from the viewpoint of those advocates of deregulation who point to the theoretical advantages of moving into free enterprise and to voice all of the other platitudes which surround the removal of government control and bureaucracy which follows. We feel that many of the existing problems could better be remedied by revision of the present system of regulations rather than by total removal. If transportation were to be deregulated and the Interstate Commerce Commission removed, there is no advocate of this course who would not concurrently require that other laws governing economic enterprise should not also apply to transportation. The antitrust laws, for example. The joke is that if we move in the direction that many people are advocating, we're just going to chisel the name "ICC" off one of those buildings in Washington and replace it with "Annex to the Department of Justice," because the same people will be looking at the same problems and developing their own system of rules and regulations and we're back to a regulatory system of a different type. We don't consider that particularly sound because transportation should be regulated by specialists. The question, then, is, what changes can we make in the rules and practices of regulation which will improve the transportation system both to the common carriers and the public which it serves?
We'd like to suggest the removal of some of the present inequities in order to strengthen the common carrier transportation system. First, we should curtail present economic exemptions. Prices on everything you happen to buy or ship are higher because certain commodities are subsidized. The exemptions should be eliminated and all parties treated equally. Secondly, common carriers should be permitted to abandon nonessential facilities. Anyone who has followed the bus or mass transit situation with any degree of care knows that it is costing us more to get people moved under public ownership than it did under private. But, under private ownership, we had a set of regulations which precluded the private bus operator from abandoning nonessential services or charging adequate amounts to compensate for services rendered. We're finding the same sort of thing developing in the freight field.
The regulatory system should permit common carriers to discontinue unnecessary services. For example, we are required to use "order-notify" bills of lading. It probably costs $20 above ordinary handling. One hundred years ago, there was no banking or credit system, the mail system was poor, and it was a necessary function. Today it is incurring extra costs which are either absorbed or passed on to other people. Similarly, there should be some method to facilitate rate increases during inflationary periods. This is the major problem facing the industry today. It is limiting our ability to keep our fleets and service levels current. We would also propose that the system preclude rates below cost and have everyone pay his fair and equal share. Under "Section 22," which the Department of Defense will not agree to eliminate, everyone is paying another tax because the common carrier system is handling freight below cost for the government. The cost is passed on to all the users of the service. We propose to let the government pay its fair share of transporting goods. We would suggest that discriminating taxation, which is hampering the ability of common carriers, be eliminated. For example, the Safeway truck is exempt from the 1½% tax on their operation while the common carrier hauling groceries to another store pays! Private trucking moves across the highway in direct competition with the common carrier, yet it does not pay the same taxes. There's a whole book that can be written about the effects of discriminatory taxes upon the railroads.
We would also suggest that the government might consider restoring the investment tax credit for facilities which are dedicated to the public. If it isn't done in this manner we'll be moving over into public ownership and then it will show up in your tax bill as a property tax or something else, which is typical of mass transit in California. Finally, the various regulatory commissions should be more adequately funded in order to more effectively correct violations and explore needed changes.
We have a pretty good transportation system in this country. The idea of a review of the regulatory methods is obviously sound. Our conclusions are that we shouldn't throw the baby away with the bath water, but some changes are indicated which would strengthen the common carrier industry, both truck and rail. To the extent that the common carrier system is strengthened, the public interest will be served.
Remarks by: Mr. Frederick G. Pfrommer
Atchison, Topeka and Santa Fe Railway Company
The transportation system of the country accounts for about 20% of the Gross National Product. The railroads measured on a ton basis handle 41% of all the intercity freight traffic. That is more than the trucks, barges, and airlines combined. Of the various kinds of transportation, 100% of rail transportation is regulated, 39% of truck transportation is regulated, and 15% of barge transportation is regulated. So we have a situation where the railroads, the single most important agency of transportation, are 100% regulated, whereas the agencies that handle less transportation are less regulated.
Now the reason this subject of regulation is timely right now is that there is a crisis situation that some of the railroads find themselves in. Out in the West, we've been more fortunate. The railroads that serve Los Angeles, for example, are all in relatively good financial condition. The problem is that although most of the really troubled railroads facing the crisis are in the East, half of all the railroad freight traffic is hauled by two or more railroads. What happens in the East to some railroad which doesn't come within 2,000 miles of California is of tremendous importance to the railroads serving California and hence it's of tremendous importance to you.
The railroads did have a monopoly on transportation at one time, and many laws were passed having that in mind. We don't have a monopoly now. The fact that we are the single largest mode of carrier doesn't mean that we have a monopoly, but we're still facing the problems of regulations that were passed when we had the monopoly.
To decide whether regulation in this country is a service or disservice it is necessary to go back and consider why the Interstate Commerce Act was passed in the 1880s, what purpose it had, whether it achieved that purpose, and whether that purpose still exists.
Regulation of railroads started because railroads were literally and practically a monopoly and the law accepted their existence and set about to regulate them. The purpose of the Interstate Commerce Act was to control the monopoly by prohibiting discrimination, requiring that all carriers charge a price which they had to make known to everybody. Over the years the Act has been amended so many times that it has truly lost its original purpose. The Act still is aimed at preventing discrimination and the other bad features. That purpose has largely been achieved. However, the Act and the ICC have actually gone far beyond the original purpose. The Commission now has the power not only to prevent discrimination and the like, it now has the power to prescribe minimum rates, maximum rates, the exact level of rates, and even the power to prevent changes in rates from becoming effective, not just upon the complaint of the public in general but upon the complaint of a competing carrier or of a user or nonuser of the service, and to hold those rates in suspension while it considers whether they should be allowed to go into effect!
Until the mid-30s, motor carriage was not regulated by the Commission. In 1932, the Commission found that unregulated trucking was subject to "internal competition induced by the ease of entering the industry." Those are the Commissioner's words, and note the emphasis is on "internal competition." In other words, the competition of truck against truck. The Motor Carrier Act was passed in 1935, and it was prefaced by a statement of national transportation policy that the rates of motor carriers should be regulated so as to preserve the inherent advantage of motor carriage and foster sound economic conditions with respect to motor carriage. The emphasis even as late as 1935, when competition between types of carriers came into effect, was upon competition of motor carrier with motor carrier. There was, at that time, little demand by shippers for regulation of motor carriers. Rate regulation, the specifying of rates, was not even an important objective of the Motor Carrier Act.
Over the years and up until about 1955, the Commission placed increasing emphasis upon whether a rate change threatened the traffic of another carrier. It wasn't a question of whether the rates were too high or too low in the classical sense; the emphasis was on competition between types of carriers. In many cases, the Commission found that a rate which the railroads proposed was compensatory, paid its way, and subsequently contributed to overhead, but nonetheless it would constitute unlawful and destructive competition because the rates, in the Commission's words, were "lower than necessary to meet the competition" of the other carrier. Now it's inherent in that approach that if you're just talking about a rate being lower than necessary to meet competition, you're trying to preserve the status quo; you're not trying to bring about change. As businessmen, you must certainly be aware that when you try to decide how low a price would have to be in order simply to meet competition you are faced with a very difficult economic decision. How in the world can you decide in advance how low your price should be to meet competition? Imagine how much more difficult that is if you are a Commissioner who may or may not have had extensive business experience but who is confronted with the competing interests of truckers, railroads, shippers, and the nonshipper who thinks his competitor is going to get an advantage! Imagine the difficulty of making a decision under those circumstances. The economic decision as to how low the rate ought to be was being set by an administrative agency back in Washington. What has happened is that the power for making the decision has been separated from the responsibility for making it. The ICC in Washington has the power to make the decisions and the carriers are left with the responsibility for the outcome.
It was originally intended that the Commission would serve as a referee between shippers and carriers during disputes. However, the Commission has now become an agency to allocate traffic between different types of carriers. Studies have been made of this intercompetitive carrier situation back in Washington. One of the groups which conducted a study was known as the Cabinet Committee or Weaks Committee. They issued the Weaks Report in 1955. The report recommended a relaxation of regulation over intercarrier competitive situations so as to let the market, rather than the ICC, determine who gets the traffic. By the time the report was translated into laws and interpreted by the Commission, the results were so watered down that they meant nothing.
More recently, a report by the Doyle Committee in 1960 or 1961 reached substantially the same conclusions. In addition, they pointed out that the proportion of traffic moving in private and not common carriage was steadily increasing. They reported that in 1946, private intercity transportation constituted 21% and by 1959 had increased to 33%. They stated that if this trend continues, private and exempt carriage would account for one half of the intercity freight traffic by 1975. In 1959, the unregulated intercity trucking of freight was 197.2 billion ton miles. In 1968, it was 241.8 billion ton miles. Water transportation increased twenty times between 1946 and 1968. Regulations which do not allow the competitive forces to take a firmer hand in establishing prices have brought about a switch to private, nonregulated carriage, threatening all of the common carriers.
The most obvious inequity of all is being put in a position where Congress approves an increase in the wage rate and not allowing a price increase to offset this. It is first necessary to file an application and have a hearing before the ICC. Testimony before Congress indicated that if during one five-year period the ICC had reached its approval within 60 days instead of at a later date, the railroads would have had an additional revenue of $1 billion!
We have the findings of economists, transportation specialists, and high government officials that the present system of transportation regulation is a disservice to this country. I can only say amen to that conclusion.
Remarks by: Professor George W. Hilton
University of California, Los Angeles
One of the attractions of attacking the present regulatory framework, as distinct from defending, it is that I can describe it as it is. The defenders have to describe it in euphemisms. I can call it a cartel and discuss it in terms of cartel theory because that's what it is and, contrary to widespread opinion, that's what it always has been.
A cartel is a group of firms which price jointly. Private efforts at cartelizing are unambiguously illegal under the Sherman Act as well as under common law previously. You can't price collusively and you can't shoot policemen. You can go to jail for doing either, unless, that is, you get the government to supervise your collusive pricing for you.
Contrary to the older point of view of historians on the origin of the ICC, the purpose of the ICC, when it was established in 1887, was not to regulate a monopolistic industry. The industry wasn't monopolistic. It wasn't engaging in extortionate pricing. American railroad rates in 1887 were, on the average, the lowest in the world. The problem was that the industry had been engaging in collusive pricing spasmodically since the 1850s and systematically since 1869. The industry was in a mature state of cartelization. The establishment of a cartel, whether it's the half dozen gas stations in the town of Morgan Hill, California, or the railroads, or something in the nature of the agricultural price support program, will attract a large volume of resources. The purpose of a cartel is to generate some monopoly gain. In the case of the railroads, the purpose was to allow them to engage in value service rate making between points they served jointly, such as Chicago and Omaha, in the same fashion as they could do to intermediate points which they served individually and in which the individual railroads had a considerable degree of monopoly power. This value of service rate making then was the purpose of their collusion.
What they found was what all cartels find—the entry of firms into the field. Eventually, though not by 1887, there were seven parallel railroads between Chicago and Omaha. You can look at a map of the American railroad system and see exactly where these cartels were. William Vanderbilt made the observation that there were five fine railroads between Chicago and the east coast with traffic enough for two of them; and that was about right. The railroads engaged in pooling of traffic or revenue as the case might be, but this was not enough. Their cartels were too unstable. There were a large number of forces for instability. The railroads would break out of the cartels when traffic fell or new railroads entered the field. They engaged in rate wars and, in general, had lower rate levels than they had previously. With the entry of new railroads, quotas were also lowered. So the industry had become impossible to stabilize within the framework of the common law, since the collusive contracts were unenforceable and it had never been established by the courts whether all this was legal, although it was generally thought that it wasn't! Most of the leading figures in the industry such as Albert Fink, the former general manager of the Louisville & Nashville and head of the southern cartel, and especially Charles Francis Adams, the president of Union Pacific, decided what they needed was a federal body to stabilize the railroad cartel by requiring adherence to public rates, by prohibiting the cutting of the Chicago-Omaha rate below the level of the Chicago-Des Moines rates when they got into a rate war, and so on. Mr. Adams was primarily responsible for thinking out what became the Interstate Commerce Commission. He couldn't call it what it was—"The Federal Railroad Cartel"—because it probably would have been declared unconstitutional. So he had to engage in a euphemism. The history of euphemisms is long. It has gone on since before 1887 and it's still going on now. You can't defend the body in its own terms as a cartel. Almost everyone will be opposed to it.
The Act Adams got was a very inadequate one, notably the reconciliation between the House and Senate versions resulted in Section 5, which prohibited pooling, which was inconsistent with the rest of the Act. It was designed to stabilize the cartels, but it prohibited the principle device whereby the railroads had been privately trying to do so.
The Act was inadequate in other respects. It didn't restrict entry. It didn't provide any powers for the Commission to set rates, and it didn't provide any controls over nonrail transportation. Water transportation was a pretty good substitute for rail transportation, except that it required horse drayage at the end, which was so inefficient that it was only an adequate substitute because of individual rates.
Congress, between 1903 and 1948, patched up the original law, contrary to the orthodox view which you heard expressed here today. However, the nature of the regulation hasn't changed.
The establishment of a cartel or, as in this case, the improvement of a cartel tended to accelerate the decline of the railroad industry. It declined rapidly relative to truck and barge transportation, which the noncompetitive character of the railroad industry had tended to stimulate. The new forms of transportation had none of the economies of scale of railroading and were easily capable of competitive organization. However, in the brief wave of revulsion to the market processes of the 1930s, the cartel was extended to the motor carriers in 1935, water carriers in 1940, and the freight forwarders in 1942. The extension was rather ineffective, however, because it was so partial. It created a cartel which comprised all of railroading, usually about a third of trucking, and about 10% of barge transportation. No cartel this partial could be effective and no one is satisfied with it at present.
The defenders of the cartel typically want the cartel expanded to the exempt section. The opponents to the cartel usually want the exempt section preserved, expanded, or made universal. A nonpooling cartel that is this partial is probably the worst organization of industry the human mind can devise! This is certainly true when you consider the other aspects of the ICC. A good cartel would have a central body in place of the ICC which engaged in mathematical computations which would equate the marginal costs members or else would provide a market whereby the members could buy and sell quotas between one another. Instead, the ICC has an irrelevant legalistic framework in the nature of a set of lawsuits.
One of the worst aspects of the ICC is that it doesn't know that it is a cartel. If you go up to the various members of the Commission and say, "Are you running a cartel?" they would recoil in horror and say, "Good heavens, we wouldn't do a thing like that, it's illegal to run a cartel. It's terrible!"
The ICC is in a literal sense an organization that doesn't know what it is doing. It's running a cartel and it doesn't admit that it is doing it. It would be better off if it did. It has a very vague verbal definition of authority rather than a directive to engage in some numerical or mathematical calculations. The personnel sit for such short periods that they can't make long-range calculations. They can't worry about what the railroad industry, the barge industry, or the trucking industry will be doing 10 years from now. They have to worry about what they'll be doing 10 years from now. They behave like everybody else, trying to maximize their utility functions, to use the economist's jargon. They generally try to implement this imperfect cartel conscientiously. The problem is not with them. They are trying to do something which is basically impossible: to run a cartel of this character effectively.
All of this is at a very considerable cost to the economy. Nobody knows exactly what it is. It probably costs the economy around $2 billion a year. If you decartelize part of a cartelized industry, the inflow of resources will drive prices down to levels lower than they would have been had there never been a cartel. The ICC typically sets rate levels so that various competing classes of carriers can get some of the business with rate differentials approximately compensating for the difference in quality of service. This results in a lot of excess capacity and freight moving in inappropriate fashions. This is like a $2 billion tax on the economy, which is used for various purposes. For what purposes? To generate some monopoly gain for truckers. Trucking would be an entirely competitive industry. The prices at which trucking companies change hands indicates that they are getting a considerable monopoly gain. They're the principle recipients of this and it's not surprising that they are the principle advocates of the present organization.
The barge lines find the umbrella-rate making aspect attractive. The railroads are restricted from cutting rates on bulk commodities, thus barge traffic is protected. The barge operators are equally enthusiastic about the present organization. In addition, they are mainly outside of the cartel. An ideal situation is to be outside of a cartel with everyone else inside. That's the principle reason why cartels are unstable. Any one member would be better off outside. That's why the ICC was established in 1887.
The railroads don't get much out of the ICC anymore. They do get an antitrust exemption which most of them cherish as though it were a bible inherited from a deceased mother. They are the recipients of subsidies from uneconomic services, the operation of passenger trains until recently, serving shippers from grain elevators in small towns where they are not permitted to tear up the track, and a wide variety of experts in the present institutional arrangements of the industry who practice before the ICC.
The regulation was never justified and should never have been undertaken. This is not an irrelevant observation. And the previous regulation is no justification for perpetuation. The industry could easily be organized competitively with a saving to the economy of $2 billion a year, and probably more. The railroads operate at 50% of industrial capacity. Regulation clogs the roads with empty truck movements and empty back hauls which the ICC won't allow to be filled.
The principle argument for regulation is that the integral nature of railroad operation makes individual pricing by railroads relatively difficult. This problem, it seems to me, has essentially cleared itself up.
The technology of the railroad industry is at the end of the line. The industry is ceasing to be workable. The rate of return has sunk below 2%. It's so low that only a massive disinvestment in the industry is practicable, although some aspects of the technology are still worthwhile investments. The industry ought to move to a technology in which everything is containerized and moves by rail, water, and highway. We ought to have competitive integrated transportation companies with an infinite proliferation of independent trucks and barge lines. The industry should be prohibited from collusive pricing. Insofar as there are any remaining monopoly elements, freedom of entry into trucking and barge operation will take care of them. It would be an industry which would present few problems to public policy. We could give up worrying about these things and devote ourselves to antequarian pursuits in universities and make traffic work quite a bit more effectively in the process.
QUESTIONS AND ANSWERS
Q. Would you identify some of the commodities that are exempt from regulation?
A. Mr. Kasper: It basically revolves around products of agriculture, including livestock. In California, it goes beyond that, due to inaction of the ICC, and involves insecticides, fertilizers, seeds, etc. If a commodity becomes exempt and goes down 20%, immediately every other commodity goes up 10%. The loss of revenue from the exempt commodity has to be made up somewhere else; otherwise, the cost of services is not going to be returned. The same is true of the private carrier. He shows a savings when compared to the average common carrier freight rate, but the common carrier has to increase the rate in order to return his costs. There's no question that when there is an exemption, those people who don't enjoy the exemption subsidize the party that has that favored position.
A. Mr. Pfrommer: The railroads have no such exemption.
A. Prof. Hilton: This simply doesn't follow. The fact that something is exempt does not mean that the cartelized rates are higher than they would otherwise be. These companies are endeavoring to maximize. In general, the ICC is helping them to do it. This has always been its purpose. The number of situations in which the rates are held down because of political pressure is relatively low. It's usually the result of farmer pressure. The more important exemptions are not the specific agricultural commodities which you asked about but the general exemption of private carriage. Any utility regulation usually boils down to something much simpler than it is usually thought to be. What regulatory commissions do is generate monopoly gain in one area and dissipate it in uneconomic services in other areas. The local regulatory commission here gives a taxi cab company a monopoly but requires it to respond to phone calls in Eagle Rock, spending $3 to send a taxi cab out to provide a 50¢ trip. In the case of the ICC regulation, this doesn't work very well because the monopoly gain is mainly generated for the trucking companies and bus lines. You can't generate monopoly gain for the regulated carriers very effectively because the people who ship the commodities in which it could be generated have the freedom to engage in private trucking. This is another way of saying the present arrangement isn't workable.
Q. What would happen if we combined the ICC and the CAB into a super-agency?
A. Mr. Pfrommer: There are too many unequal policies under which the various agencies operate. The CAB for example has certain promotional duties. The ICC has none. I believe that uniformity of promotional policies is desirable. The combination of agencies is really an unanswerable question unless you specify what other changes are going to be made in the substantive law.
A. Mr. Kasper: I agree with Mr. Pfrommer. Just to add them together would compound the problem. A man would have to be an expert in three different fields as compared to one, today.
A. Prof. Hilton: My guess is that it would probably be better than the present arrangement because almost anything would be. If the cartel were reorganized, it would probably be a less wasteful cartel. We've surely learned something from the present organization; but it would still be a cartel. In the case of airlines, there are no apparent economies of scale. PSA appears to operate as economically as American Airlines in a technological sense. That regulation was never justified either. The regulation of air that's justified is pricing the use of the airways. Since there are no property rights in the air and airports are operated publically, government does both of these things imperfectly. What you ought to have is a deregulation of air also, and let anybody fly anywhere he desires provided he meets the safety requirements and pays the user charges through the government. The air regulation does exactly what the ICC regulation does; it wastes resources. It's just a comprehensive incentive to fly semi-empty airplanes around the country. In the case of the Federal Maritime Board, we're trying to operate a merchant marine in the absence of any competitive advantage. Our Merchant Marine policy ought to be friendliness with the Norwegians. So I don't question that a super-agency would be better but, better yet, I would want to get rid of all of them.
Q. What is your opinion of the shippers' attitude toward regulation?
A. Mr. Kasper: They consider the alternatives which have been suggested thus far as more objectionable.
A. Mr. Pfrommer: I disagree. The National Industrial Traffic League has expressed itself as being in favor of many of the railroads' lessening of rate regulation proposals.
A. Prof. Hilton: It doesn't surprise me that you don't get shipper unanimity. Most shippers would rather have certain rates, even if they are higher than uncertain rates, because somebody else may get the advantage of the lower one. This resulted in a lot of shipper pressure for the Act of 1887. Security of expectation can be provided without the present cartelization. It can be provided as it is in the grain markets, for example, by professional speculators in hedging operations. What I am arguing for is an organization of the industry roughly like the tramp steamer market. If you want security of expectation as to a tramp steamer a year hence, you make a contact with someone on the Baltic Exchange in London to provide you with a tramp steamer on the day you want it. The professional speculator takes the risk exactly as one would in a grain market. An organized market should be established to provide containerized transportation of standard sizes and of various types for people who want that type of security in the future.