A Case Study of the Costs of Rate Reregulation: America’s Freight Railroads versus Shipper Industries

posted by Robert Shapiro on April 5, 2022 - 12:00am

The railroad industry can give us some singular insights into the conditions, costs and benefits of economic regulation, and today’s essay is for those interested in those insights.

When Congress created the Interstate Commerce Commission (ICC) in 1887 to regulate railroad routes and rates, it made a great deal of economic sense.  Railroads had become the only economical way to move many materials and goods over substantial distances, and a handful of railroad barons including Cornelius Vanderbilt, Jay Gould, and Leland Stanford had secured strangleholds over much of the nation’s commerce.

Many decades later, developments following World War II overtook those concerns.  Freight trucking had eroded rail’s dominance of domestic transport, especially once the interstate highway system was in place; and their competition with the continuing regulation of railroad rates and routes depressed rail industry investment and left most large railroads bankrupt or nearly so.  Congress finally deregulated the industry in 1980, allowing railroads to end unprofitable routes and consolidate into more efficient and financially sound networks based on very high rates of new investment.  The productivity gains from those changes were so strong that most freight rail rates fell sharply, and the United States now boasts the world’s most efficient freight rail industry.

At the request of the Association of American Railroads, I recently examined proposals to unravel part of this record by reestablishing broader rate regulation in certain cases.  As it is, the Surface Transportation Board (STB), the successor to the ICC, retains authority to set freight rail rates under very limited conditions.  For example, a large railroad’s network typically includes places where it alone serves a particular span, and other rail carriers can access those single-service tracks and facilities for an agreed-upon fee.  However, if the shipper engaging the second carrier objects to the proposed fee, it can petition the STB for rate relief.

The new proposal would revise the rules under which a petitioner has to show that the railroad controlling the single-service span has an effective monopoly and that its proposed fee is unreasonable.   The problem for shippers that unsurprisingly want to pay less is that those conditions are hard to establish—and appropriately so given the impressive record of rate deregulation.  For example, the effective monopoly condition must take account of alternative modes of transport such as trucking and alternative routes that avoid single-service points.

The shipper industries pushing the proposal also argue that the railroad industry already earns revenues adequate to cover their cost of capital for future investment without charging higher rates for single-served locations. But when did profitability become the basis for government setting an industry’s rates?  And if it were so, major shipper industries should pay not less but more, since their “revenue adequacy” is far greater than the most profitable railroad.

Beyond these technical issues, the proposal would directly affect the quality of rail service to single-served locations by reducing the revenues to support that service.  Those reduced revenues also could lead to higher rates on other routes.  Most important, this regulation of rail rates would reduce the investment levels across the freight rail industry, the basis for the industry’s current efficiency and lower rates as well as its financial health. The proposal would discourage future investment by directly reducing the industry’s resources for investment and creating new uncertainty about the returns on investments at single-service facilities. 

And this would unfold just at the time when railroads need to double down on investments to meet growing competitive pressures from freight trucking and the challenge from climate change to strengthen the resiliency of their equipment, facilities, and operations.

This type of debate is a regular feature of Washington these days.  A large company or an industry asks Congress or a regulatory agency to tilt the playing field in its favor and at the expense of other companies or industries and customers.  It’s a hybrid of interest group politics and crony capitalism, and the STB should simply say No.

To learn more, here’s the link to the full analysis:  Reciprocal Switching and the Economics of the Freight Rail Industry.