45-855 Railroads, The First Big Business: Topic 10

10. Railroads and the Dead Hand of the Government

1. State Regulation of Railroads


1. Under the English Common Law all businesses were public by definition, and all came within the jurisdiction of the legislature. Legislatures had the power to set prices and to regulate business under their police power. Price fixing persisted for many callings well into the 19^th Century. For example, innkeepers, tavern keepers, bakers, millers, carriers (porters, couchmen, etc.) had their maximum fees/rates fixed in law.
   
   
2. Early American canal, bridge, and turnpike companies received corporate charters. Because these were intended as monopolies and cheapness was one of the intended attributes, the legislature set the maximum toll which was uniform in distance. Hence, no discrimination against persons or places. Anyone could use the "highway" by paying the toll according to the distance used. A shipper would then pay the toll and a fee to the carrier (wagon, barge, etc.) for services rendered.
   
   
3. However, railroads were very different. The peculiarities of railroad transportation were such that the railroad had to own both the highway and the carriers using the highway! This fact plus the high fixed costs of railroads inevitably lead to discrimination against persons, places, and types of traffic.
   
   
4. The high fixed costs of railroads and the pricing system they produced, inevitably led to efforts to regulate railroad passenger and freight rates by the States.
   
   
5. State politicians soon discovered that uniform or prorata freight charges were impractical. Capitalists and entrepreneurs simply moved to another state with more rational regulation. It was recognized quite early that discrimination against types of traffic was essential.
   
   
6. Discrimination against places was a difficult problem to solve. As the oyster example shows, what is "fair" here is not easily determined. Most state regulatory schemes tried to address the problem with some form of the short haul pricing constraint (SHPC). For example, if A, B, C, and D are cities in that order along a railroad line then the rate from A to B, R_ab must not exceed the rate from A to D; that is,
   R_ab £ R_ad.
   
   
7. For example, in the state of Iowa prior to the railroads, the Mississippi river towns were the primary shipping points for farmers' grains. The grains would be loaded on steamboats and sent down to New Orleans for export. With the arrival of the railroads -- the first railroad bridge across the Mississippi was built at Rock Island in 1856 -- the farmers could ship their grain to Chicago and from Chicago it could go to the Atlantic coast via either lake steamer or one of the trunk lines. In the fierce competition for business, it was often the case that the railroad rate from the Iowa interior to Chicago was lower than the rate from the interior to one of the Mississippi river towns! Hence the push on the part of the river town business people for railroad rate regulation within the state of Iowa.
   
   

8. These freight rate discriminations were one of the key reasons for the dislike of the railroads and the visible railroad leaders such as William H. Vanderbilt.
   
   

9. By 1876 most states had passed laws regulating rates inside their borders (intrastate rates). Many of these laws were patterned after the Massachusetts law which set up a quasi-judicial commission to adjudicate disputes between shippers and the railroads.
   
   
2. Munn vs. Illinois
   
   
1. In 1877 the Supreme Court upheld the right of the states to regulate railroad rates.
   
   
2. Chief Justice Waite used the old 17^th Century custom in English jurisprudence that accepted the regulation of a business clothed with a public interest. "When Private Property is devoted to public use, it is subject to public regulation." For example, a privately owned wharf.
   
   
3. One of the dissenters, Justice Stephen J. Field, argued that the regulation of railroad rates was in effect confiscation of private property. The railroads were being deprived of property without due process of law in violation of the 5^th and 14^th Amendments. This argument later became known as substantive due process.
   
   


3. Wabash, St. Louis, and Pacific Railroad vs. Illinois
   
   
1. In 1886 the Supreme Court in effect reversed the Munn case and struck down an Illinois law regulating railroad rates.
   
   
2. The Court argued that State railroad regulation violated the interstate commerce clause of the Constitution. Only Congress could regulate interstate commerce.
   
   
3. In a companion case, Santa Clara County vs. Southern Pacific Railroad, the Court defined the SPRR as a legal person! Hence, the 5^th and 14^th Amendments were applicable.
   
   


4. The Interstate Commerce Act of 1887
   
   
1. All this turmoil led to the passage of the ICA in 1887.
   
   
2. The Act outlawed rebates, drawbacks, and pooling. It required the railroads to post the rates in every depot and station and required the rates to be "reasonable and just".
   
   
3. The Act contained a Short Haul Pricing Constraint.
   
   
4. Finally, the act set up a Commission to adjudicate disputes between shippers and the railroads. The ICC was the first federal government regulatory agency.
   
   
5. Social Costs -- Best guess is that the ratio of losses to gains was about 2 to 1. Short haul freight rates fell about 15 to 30 percent while long haul freight rates rose. Because about 2/3 of the traffic was long haul freight, the losses of the long haul shippers were much greater than the gains of the short haul shippers.
   
   
5. Enforcement Problems
   
   
1. The ICA was vaguely written and did not have the independent means to enforce its determinations.
   
   
2. The actions of the ICC could be appealed to the federal courts and it took about 4 years to settle any particular point of dispute.
   
   
3. During the first 10 years 90% of the ICC's rulings on rate charges were reversed in federal court. Consequently, the number of shipper appeals fell sharply.
   
   
6. The Reconstruction of the Railroad System: 1900-1915
   
   
1. During the tremendous expansion of the economy after 1896 the railroad system in the U.S. was almost totally rebuilt in order to keep up with the demands on the system.
   
   
2. Between 1900 and 1915 railroad mileage increased from 259,000 to 391,000 miles and the number of locomotives increased from 36,000 to 66,000. Heavier steel rails were laid down and most important routes were double and quadruple tracked. Locomotives became bigger and heavier as did the hopper and freight cars. Steel bridges replaced older wooden ones and enormous stations were constructed in almost every major American city.
   
   
3. The productivity gains were impressive up to about 1910. After 1910 the strict government regulation removed the railroads' ability to control their prices. The railroads had been plowing enormous capital back into their systems so that improvements kept up with traffic demands. Afer 1910 the railroads were increasingly squeezed by higher and higher labor costs, an ever increasing demand for their services, but no ability to raise prices in response.
   
   
4. "Progressives" believed that freight rates should not be so high so as to generate a surplus for the railroads. If there was a surplus, then the railroads should lower their rates so as to give the surplus back to the "people". It was the responsibility of investors to expand the physical plant. After the investors were paid their dividend, any surplus should go back to the "people". The "Progressives" did not understand the idea that a "surplus" could be reinvested in the company! This forced many railroad leaders like James J. Hill to hide their surpluses in the costs side of their ledgers in order to have the capital necessary to improve their roads.
   
   

7. Elkins Act of 1903
   
   
1. Partly in response to pressure from the railroads, Congress made it illegal to ask for a rebate.
   
   
2. In the original ICA, railroads could be punished for giving a rebate but if shippers asked for one, that was not a criminal act.
   
   
8. Hepburn Act of 1906
   
   
1. Authorized the ICC to set maximum rates and to order railroads to comply after 30 days.
   
   
2. Set up a system of fast appeals in the Federal Courts.
   
   
3. Instructed the courts to accept ICC rulings until evidence was massed to the contrary. In effect, railroads were guilty until proven innocent!
   
   
9. Mann-Elkins Act 1910
   
   
1. Federal courts removed from the process. The ICC was empowered to suspend proposed rate increases.
   
   
2. Railroads were forbidden from acquiring competing lines.
   
   
3. Jurisdiction of ICC expanded to telephone, telegraph, cable, and wireless companies.
   
   
10. The Adamson Act of 1916 (the 8-Hour Day) -- Mandated the 8 hour day on the railroads as of 1 January 1917. This substantially increased the labor costs of the railroads. No rate increase was granted by the ICC to make up for the increased costs.
    
    

11. Most of the major railroads were bankrupt by 1917. Almost no rate increases were granted by the ICC between 1907 and 1917. The railroads applied for rate increases in 1911, 1913, 1914, and 1917, and were only granted some very minor increases in 1914. At the same time, labor costs increased steadily through this period. With no control over their prices, rising labor costs, and an explosion in demand, the railroads increasingly went into debt in order to finance the necessary upgrades to their systems. When the government nationalized the railroads in 1917 they were mostly bankrupt. Finally, but too late, the railroads were granted a rate increase in 1918 equal to what they had asked for over the previous 7 years. But, by 1919, it was too late for the railroads. Capital flowed into the automotive, radio, and electrical industries and it was too late to integrate the motor freight lines into the railroads.
    
    

12. Transportation Act of 1920
    
    
1. To make up for some of the damage, Congress instructed the ICC to set minimum rates. This was intended to make certain that the railroads had an adequate income.
   
   
2. The ICC was granted more authority over entry, exit, and consolidation of the railroad industry.
   
   
13. Setting minimum rates backfired because the emerging trucking industry was able skim off much of the high value short haul freight business.
    
    

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