Throttling the Railroads: 5. Early Regulation - 1887-1920

Dr. Carson is a frequent contributor to THE FREEMAN and other journals and the author of several books, his latest being The War on the Poor (Arlington House, 1969). He is Chairman of the Social Science Department at Okaloosa-Walton College in Florida.

There have been three stages of government regulation of the rail­roads, though a fourth one appears to be taking shape in recent years. The first stage was that of state efforts at regulation and control, a stage which encompassed such regulation as there was until 1887. In the second stage, 1887-1920, the Federal government began its reg­ulatory intervention and to occupy much of the field. The third stage is bounded by the years 1920-1958, and the Federal government has been the dominant intervener in this period. Since 1958, govern­ments have begun a hesitant shift back toward the much earlier prac­tice of offering subsidies to the railroads.

There have been two different levels of restrictive intervention which cut across the chronological stages. The most obvious level is that of direct governmental inter­vention by which governments act­ing by legislation or through com­missions have regulated, controlled, restricted, obstructed, prescribed, taken over, aided, or inhibited the railroads in the conduct of their business. The other level is the one on which governments have inter­fered indirectly by the empowering of labor unions to carry on their activities of extracting agreements from the roads as to working con­ditions and wages, have aided and subsidized competitive modes of transportation, and have in vari­ous ways established surrounding conditions within which railroads operate.

There is no need here to dwell on the first stage of regulation—that by the states before 1887. Suffice it to say that many of the devices and objects of regulation were in­troduced and tried by the states, such as the establishment of regu­latory commissions, prescriptive legislation, rate control, and re­quirements as to service. The ex­tent of such regulation varied, of course, from state to state and from time to time. Some of the Midwestern states made the most extensive and restrictive efforts. State regulation did not end, either, with the beginning of Federal ac­tivity in 1887; certain intrastate rail operations have continued to fall under the states; but, increas­ingly over the years, the Federal government has pre-empted more and more of the field.

Federal Intervention and the Crisis of World War I

In any case, the damage done to the railroads by the states was spotty, sporadic, and tended to be localized. Not so, that of the Fed­eral government. The Federal gov­ernment’s intervention intensified from its beginning in 1887 until World War I; the effects reached to virtually all the railroads in the country, and the tendency was to tighten control ever more effec­tively.

The bitter fruits of this inter­vention came rather swiftly, and they were such as should have been expected from it. Indeed, attempts to fix rates were less than a decade old when intervention led to a full-fledged crisis. World War I precipi­tated a crisis for which the inter­vention had prepared the way. Even before the United States de­clared war, there was widespread awareness that the railroads were in no position to perform all the services that were expected of them. Exports, mainly to the Allies, in 1915 and 1916 greatly increased the amount of freight traffic. By the time the United States entered the war, government and railroad officials were discussing means and organizing for improvement of rail services. This did not work, and as the months passed in 1917, the situ­ation worsened.

Poor performances in coal produc­tion and distribution led the list of transportation difficulties, although alarm over adequate shipping for food exports and the grain harvest ran a close second. As autumn passed dangerous lows in coal supplies were reported throughout the nation…

Between August 12 and November 24 the drop in coal production due to car shortages totaled 20,166,412 tons.

… By December the possibility of completely empty coal bins faced New England factories and homes. Nor was the coal famine the only major national problem; the annual grain harvest was moving to market slowly because of car shortages and blocked rail facilities…. Terminal congestion was frightful. Around New York City unloaded freight was actually piled in the space between tracks.¹

The war exposed the condition of the railroads by placing unusual demands on them, but the war was not the source of the incapabilities of the railroads. The truth was that the United States did not have an integrated rail system: the rail­roads did not cooperate well with one another; traffic did not flow by the best routes; many railroads were in a state of disrepair; and the routing of boxcars was largely uncoordinated. Despite the fact that historians have long written of transcontinental railroads, there is not to the present day a single transcontinental railroad.

The source of the crisis was the government measures of the pre­ceding three decades. On the one hand, the government attempted to force the railroads to compete; on the other, it refused to allow them to compete. The government pro­scribed certain kinds of coopera­tion, attacked efforts at coordina­tion, refused to allow rates to rise in crucial circumstances, and pro­duced conditions in which railroads were considered a relatively poor investment. The thrust of govern­ment into railroad regulation had produced an ineffective and disin­tegrated rail system. To see how this was done, let us turn now to an examination of the regulation.

The Interstate Commerce Act

The first Federal act of regula­tion was the Interstate Commerce Act, and it was also the basic act from which much of the rest has flowed. This complicated statute, passed in 1887, had many provi­sions with qualifiers attached to them and the whole was cast in the extensive verbiage and redundan­cies by which a law is made to close as many loopholes as may be de­sired. Stripped to their essence, these were its provisions. It was to apply to all interstate freight and passenger traffic by rail. All rates for such traffic should be just and reasonable. Any and all rebates were prohibited. The railroads should not give any unreasonable preference or advantage to any shipper over any other, and should make their services available to all corners on equal terms. A railroad should charge no more for a short haul than a long haul on the same route under substantially similar circumstances, with the proviso that the Interstate Commerce Commission could relieve a rail­road from its obligation to conform if circumstances warranted. The pooling (dividing up) of either freight or receipts among com­peting railroads was prohibited. Rates and fares were to be posted prominently, and not to be changed until public notice had been given. And lastly, it provided for the es­tablishment of an Interstate Com­merce Commission to enforce the provisions of the Act.

There were many minor amend­ments to the Act during the early years, amendments which had the general aim of spelling out and in­creasing the powers of the Com­mission. For example: "In 1888 the act was amended to cover clas­sification…. In 1889 it was amend­ed to provide for the proper pub­lication of freight and passenger tariffs…. In 1889 and 1891 the Interstate Commerce Act has been amended to strengthen the powers of the Commission to compel at­tendance of witnesses and the pro­duction of documents at the hear­ing of complaints. This provision was further amended in 1895 to protect witnesses from the penal consequences of their own incrimi­nating testimony and to punish re­calcitrant witnesses by maximum penalties of $5,000 fine and one year’s imprisonment."²

Other Restrictive Legislation

The other major acts affecting the railroads before World War I, however, were the Sherman Anti­trust Act of 1890, the Elkins Act of 1903, the Hepburn Act of 1906, the Mann-Elkins Act of 1910, the Panama Canal Act of 1912, and the Physical Valuation Act of 1913.

Railroad men generally assumed at the first that the railroads were exempt from the Sherman Act since they already fell under re­strictive legislation, but the Su­preme Court was soon to rule otherwise. The ostensible purpose of this antitrust legislation was to compel competition. Yet a close ex­amination of it shows that mean­ingful competition is actually out­lawed if the statute were to be lit­erally applied. Section 2 says, in part, that "every person who shall monopolize, or attempt to monopo­lize, or combine or conspire with any other person or persons, to monopolize any part of the trade or commerce among the several States, or with foreign nations, shall be deemed guilty of a misde­meanor…." Certainly a major reason for anyone competing in commercial activities is to gain a larger share of the market. By do­ing so, he would, in effect, be at­tempting to monopolize all the trade or commerce in his particular business, though he might not be conscious of so extensive an ambi­tion. Though the statute may not have been applied in just that way, it has been applied to deter growth and expansion and reduce effective competition.

The Elkins Act made it a mis­demeanor for railroads to deviate from the published rates, defined unfair discrimination more fully, and provided punishments for of­ficials who might be involved in giving or receiving rebates.

The Hepburn Act was much more extensive; it was comparable to the Interstate Commerce Act as major legislation, and gave the Commission far more power than it formerly had. This Act empow­ered the Commission to fix maxi­mum rail rates according to the prescription that they should be just and reasonable. The Commis­sion could prescribe uniform sys­tems of accounting for the affected carriers. Moreover, railroads were prohibited from transporting any goods produced by themselves or of companies in which they held an interest except such as would be useful to them in maintaining their roads and related operations.

The Mann-Elkins Act once again extended the jurisdiction and pow­ers of the Interstate Commerce Commission. The provisions for charging no more for a short than a longer haul were greatly tight­ened. The new act "absolutely for­bade lower charges to longer-dis­tance points except after hearing and approval by the Interstate Commerce Commission."^³ The Commission could suspend new rates proposed by the railroads un­til the court had rendered a deci­sion. The act provided that if a rail­road lowered its rates to compete with water traffic, it could not raise them later—after having driven water carriers out of business—until a hearing had been held that would show that some other condi­tion had changed besides the re­moval of water competitors. A Fed­eral Court of Commerce was set up to hear appeals from the decisions of the Commission, but it was abol­ished two years later.

The Panama Canal Act "pro­vided that after July 1, 1914, it should be unlawful for any railroad to own, lease, operate, or control or have any interest whatsoever through stockholding or commu­nity of management, in any water carrier operating through the Panama Canal. Neither was any such relationship to continue else­where than through the Canal in cases where the railroad did or might compete with the water line for traffic."⁴ This was an attempt to make the railroads compete with steamships.

The Physical Valuation Act was supposed to aid the Commission in setting rates or determining if rates were just and reasonable. The underlying idea was that a rate should ideally be such that an effi­cient carrier would receive a "fair return" on his investment and that this could somehow be calculated if the value of the property could be ascertained. To that end, the Commission was to make exhaus­tive computations as to the costs to the railroads of all their proper­ties. The Commission was to "re­port for each piece of property the original cost to date, the cost of re­production new, the cost of repro­duction less depreciation, and `other values and elements of value, if any.’ " The railroads were "re­quired to aid the Commission by furnishing maps, profiles, con­tracts, and any other pertinent documents and to cooperate in any way desired in the undertaking."⁵ This act is interesting not for any results produced, though the Com­mission labored many years to try to arrive at the required conclu­sions, but for what it indicated about the extent to which legislators were willing to go to regulate the railroads.

It should be clear from the above summary of the legislation prior to World War I that the Federal government was gaining more and more control over the railroads and that, conversely, the railroads were more and more cir­cumscribed in what they could do. In addition, labor unions were be­ing given more and more power, but that story will be told in an­other connection. Something does need to be said about the tendency of court rulings.

The Commission Gains Power

The chances are good that had the Supreme Court been con­fronted in the 1890′s with an In­terstate Commerce Commission clearly clothed with the quasi­legislative-judicial-executive pow­ers which it was later to exer­cise, it would have declared such a body unconstitutional. At any rate, it is clear from the decisions of the 1890′s that the Court con­sidered the Commission to be only an advisory body. Certainly, it did not recognize the Commission as a court; no more could it leg­islate or execute. But then, neith­er was such a body in violation of the Constitution. However, the Commission struggled vigorously over the years to have its powers increased, and they were. In the early years, the Court circum­scribed the powers of the Com­mission by ruling on the basis of legislative intent. The Court thus allowed the issue of the constitu­tionality of such a body to disap­pear; meanwhile, the legislature made it ever clearer that they in­tended the Commission to have more and more power. Thus it was that the Federal courts were by World War I largely adjuncts of the Commission in enforcing their rulings.

Undoubtedly, many of those who sought to regulate the rail­roads in many ways had the best of intentions. They sought to es­tablish just and reasonable rates, extend the benefits of competition to those not receiving it, provide similar services for all shippers, al­low the railroads a "fair return" on their investment, and see to it that the general public were bene­ficiaries of railway services. Good intentions, however, have no dis­cernible effect on results; these are a product of the actions taken. The acts of the regulators were often contradictory, self-defeat­ing, ignored the nature of rail competition, and harmful both to the railroads and the general pub­lic. The results were such as should have been expected from such acts.

Even the intent of the regula­tors as to competition is not clear.

On the one hand, they apparently wanted to preserve it; on the other, they wanted to prevent it. One writer describes the aim of part of the legislation in this way: "It attempted to continue compe­tition at points not naturally com­petitive by the prohibition of traf­fic agreement, and at the same time to protect other points against such competition by mak­ing it unlawful for the railroad companies to discriminate in fa­vor of artificially competitive points."⁶ By outlawing rebates, the government attempted to stop that sort of rate competition.

Competition Restrained

Certainly, one of the ways in which businesses compete with one another is in price. If prices cannot vary from the list price, that sort of competition is greatly reduced. Another way railroads might compete with one another was in services. But if services had to be extended to all comers on an equal basis, as the law required, a railroad would be greatly hamp­ered in offering better services to a particular shipper than an­other line would offer him. When a railroad could not work out a more favorable agreement with a connecting line than others could, it was that much more difficult to offer a better price.

The long and short haul clause sometimes made it prohibitive for a weak road to haul commodities long distances at rates competitive with alternative routes. To do so it would have to lower its rates for shorter hauls to a point that would make them unremunerative. A port city, for example, served by finan­cially weak railroads could not ex­pect to compete with ports served by stronger roads. This situation was aggravated by the Panama Canal Act which tended to discour­age favorable rail and steamship rates for a particular port. In short, all sorts of competition were hamp­ered by regulation.

As rail regulation became ever more restrictive, it tended to freeze the rail system in its exist­ing pattern. There is every reason to suppose that in the absence of hampering and prohibitive legis­lation these United States would have had by or before World War I a few great railroad systems spanning the continent in its length and breadth and providing not one but several unified sys­tems of transport. These, in turn, would have been linked with steamship lines to the rest of the world. These several systems would have been in position to compete effectively with one an­other as, for example, great oil companies do today. Certainly the tendency was toward the linking together and forming of such systems prior to the restrictive legislation.

Financiers in Control

The question is, what froze them into the early pattern? One might suppose that it was anti­trust action which prevented or prohibited such unification. Yet antitrust suits did not prevent such expansion and unification be­fore World War I, to my knowl­edge. Instead, it was the railroad financiers who turned their atten­tion from expanding into new ter­ritory and linking together truly transcontinental systems to com­bining railroads serving the same general area, an effort which has continued to the present day. The most famous early example of this was the formation of the North­ern Securities Company. This was a holding company for the con­trolling stock of the Northern Pacific and Great Northern, two roads serving the same general area. The Supreme Court ordered the holding company dissolved in 1904.

Financiers could and did, how­ever, manage to gain control of railroads serving the same gener­al area by stock purchases. For example, "The traffic of the East and eastern Middle West was dom­inated by the New York Central and Pennsylvania, allied with the Morgan interests, which controlled the Chesapeake and Ohio, the Bal­timore and Ohio, and the Norfolk and Western. Under Morgan’s di­rection, moreover, the New Haven bought control of the Boston and Maine, the trolley lines of New England, and even the Long Island steamship companies."⁷ The tend­ency of such controlling combina­tions—there were several over the country—was to divide the country into noncompetitive rail­road empires, reduce competition within an area, and to delay or prevent integration. If the threat of antitrust action did not prevent such combinations, it is reason­able to suppose it would not have prevented combinations aimed at building integrated transconti­nental systems.

Long and Short Haul Rules

We must look elsewhere than the antitrust legislation for an ex­planation of why financiers did not see any great prospect for profit in building great nationwide systems. It is not necessary to look far, because the long and short haul rules provide a suffi­cient reason, especially when com­bined with the rules inhibiting competition. An ideal railroad under the long and short haul clause would be one whose main line connected two or more major shipping centers at considerable distance from one another with only a few intermediate points spaced far apart. In fact, it might be ideal if there were no inter­mediate stations, for rates could then be set to take full advantage of the economies of operation in­volved in pulling long trains for very long distances. But a rail­road connecting, say, Omaha or Kansas City with Los Angeles or San Francisco might approach the ideal under the long and short haul restriction.

Indeed, there were, and are, several roads well situated to profit from this peculiar regulation. They are such Western roads as the Santa Fe, Southern Pacific, Union Pacific, and Northern Pa­cific. But there is a counter incen­tive to linking these roads with those in the East which traverse thickly populated areas with nu­merous intermediate points. This would only serve to tie what had been profitable long haul rates to short haul rates in such a way as either to incur great losses in the short haul business or to price themselves out of much of the long haul traffic. In practice, any East­ern and Western system so linked would be at the mercy of those Western roads free of such ties.

Since the railroads could not effectively compete in so many ways, such opportunity for improving their situation as existed would usually be to combine roads cover­ing the same general area so as to maintain some control over rates and get as much of the profitable business as possible within an area. This is what rail­road financiers tended to do. The result, as far as the public was concerned, was a nonintegrated rail system, reduced competition, poorer service, and higher rates.

Other Inhibiting Factors

There were other infelicities produced by regulation. Even where they desired to do so, rail­road men were hampered in co­ordinating services and charges with one another. Not only was pooling prohibited but any other sorts of agreements might make them subject to antitrust suits. It is difficult to imagine an agree­ment which the officials of two or more railroads might enter into that might not be construed as an attempt to monopolize the trans­port business of an area. Certain­ly, if they made any agreement it would likely be with the pros­pect of increasing business, and any such increase would "tend" toward monopoly.

If rate regulation worked as simply as it has sometimes been conceived, it would have the effect of coddling the inefficient. That is, if by raising rates the income of the railroad could be proportion­ately increased, and if the Com­mission wanted to keep every line in operation, the maximum rates would be those which would yield a profit to the most inefficient line. Such rate setting would have the interesting result of pushing all rates upward insofar as uniform rates prevailed. The Commission has not, of course, behaved in so simplistic a fashion. Even if it did, the demand for rail service is not inelastic. In consequence, rates can be increased without necessar­ily increasing revenues. The Com­mission tried to steer a course between raising rates so high that they would reduce traffic appre­ciably and keeping them so low that many railroads would be ruined. The results were a mixed bag also in the years before World War I: rates did generally rise; some rates were kept too low; many roads were caught in the squeeze of declining revenues.

Statistics indicate that railroad earnings declined after the Inter­state Commerce Commission be­came involved in setting rates. The "aggregate amount paid in divi­dends fell off $100,000,000 from the high year of this period (1911), and the average rate on dividend-paying stock which was 8.07 per cent in 1908 was 6.75 per cent in 1916. Whatever may be one’s per­sonal view as to whether this was or was not a satisfactory financial showing for our railroad system, the fact remained that it did not satisfy the investor. Consequently, the sound policy long practiced by railroad management of keeping ahead of traffic by providing the necessary facilities for handling it was gradually weakened, and at the time the country entered the war the railroad system was far short of that standard of efficiency which the demands of traffic re­quired."⁸ One of the signs that the railroads were not spending nearly enough on new equipment was the increase of accidents. Ac­cidents due to derailments in­creased from 6,697 in 1911 to 22,477 in 1920.⁹ In short, govern­ment policies reduced earnings, discouraged investment, and set the stage for the railroads to live off past capital investment to the detriment of efficient maintenance.

When World War I came, the railroads were ill prepared to pro­vide the services wanted. This was, in large measure, due to government policies which had frozen the railroads in an earlier pattern, made it difficult for own­ers and managers to run them ef­fectively, discouraged investment, supported inefficiency, deterred cooperation and coordination, and inhibited the development of na­tionwide systems. The Federal government took over the opera­tion of the railroads on December 26, 1917, and continued to run them until 1920. Having prevented an integrated system from devel­oping and thus having set the stage for a crisis, the government took over and did much that it had prevented the railroads from do­ing.

Next: Railroads in the Grip of Government.

 

—FOOTNOTES—

¹ K. Austin Kerr, American Railroad Politics (Pittsburgh: University of Pitts­burgh Press, 1968), pp. 54-55.

² Henry S. Haines, Restrictive Rail­way Legislation (New York: Macmillan, 1905), pp. 223, 261.

³ Frank H. Dixon. Railroads and Government (New York: Scribner’s, 1922), p. 30.

⁴ Ibid., p. 83.

⁵ Ibid., pp. 70-71

⁶ Haines, op. cit., p. 326.

⁷ Arthur S. Link, American Epoch (New York: Alfred A. Knopf, 1955), p. 53.

⁸ Dixon, op. cit., pp. 23-24.

⁹ Ibid., p. 78.