Transport Deregulation: An Economic Necessity

Mr. Semmens is an economic analyst for the Arizona Department of Transportation and is studying for an advanced degree in business administration at Arizona State University.

It has been said that change is the only constant in an age of continual upheaval and, hopefully, progress. The pace of change has been ac­celerating to the point where there is talk of “future shock.” Yet, in the face of this dynamic environment we are presented with the hoary old institutions of a previous era as a means of managing and allocating a very vital service.

In some circles it is maintained that railroads as a private entity are passé, that railroading is no longer a viable business venture. But the need to transport bulk goods from their source to their ultimate users still exists. Railroads would appear to offer a convenient and inexpensive method of moving these goods. Thus the stage is set for a profitable enter­prise. Simultaneously, however, railroads face bankruptcy and are threatened with imminent govern­ment take-over. What is the prob­lem?

The problem would seem to be the environment in which the railroads must operate. Under the rules devised by the slow-moving Inter­state Commerce Commission, productivity is sacrificed to other goals. Technological innovations are discouraged in order not to harm other firms, and excess capacity is mandated to serve negligible demand. The manage­ments of the various railroad firms are expending a large portion of their efforts in hassling with the regulations and the regulators. This is not the most efficacious use of the resources involved.

How and why did this set of cir­cumstances arise? Whether one is partial to the traditional interpreta­tion of the origins of rail regulation as a response to the evils of monopolistic robber barons or the revisionist theory of big business complicity in the establishment of an industry-controlled I.C.C., the fact remains that the concept of regulation is static in nature. It seeks to preserve, maintain, or cap­ture in some way an ideal set of rela­tionships between the providers and users of a given service. It is essentially backward looking and dominated by the myth of a golden age that, like all utopian visions, is inflexible to changing times, needs, and circumstances. No sooner are the regulations laid down than they are obsolete in some small way. Over time the obsolescence pro­ceeds to the point of absurdity, the result being massive misallocation of resources and waste, as in the case of the I.C.C.’s regulation of the transportation industry.

Some criticism of regulatory com­missions has been made on the grounds that such bodies are the repositories of political hacks, washed up bureaucrats, and shyster lawyers. But the deficiencies of regulation are more endemic to the system than can be resolved by simply choosing better regulators. The selection of the new regulators and, more importantly, the ele­ments affecting the performance of a largely illogical and unfeasible task would be subject to the same pressures that shape the current situation. These pressures lie in the fact that government is an agency charged with administration of “justice”—an ill-defined commodi­ty at best, subject to diverse political interpretations. In con­trast, the provision of services to a consuming public is a question of economics—a field where efficiency in the allocation and consumption of scarce resources is of paramount importance. Justice and efficiency do not always coincide, especially since “justice” may often be in the eye of the beholder.

The I.C.C., in conformity to the governmental procedures designed to produce justice, or some approx­imation of the current interpreta­tion of what this means, takes on a quasi-judicial character. The pro­ceedings are basically adversary in nature with the same time-consum­ing attention to detail as the court system with similar results. In the end the attempt to hear all par­ticipants and to balance all their interests is not very likely to produce a policy geared to the most efficient utilization of limited resources to meet insatiable desires.

Waste Not, Want Not

The burdens of regulatory policy are more than just aggravation with delay. The costs have been and will continue to be substantial. The prices that the consumer must pay for the bloated bureaucracy that ad­ministers regulatory policy, for the inefficient use of current resources and for the misallocation of invest­ment, are very real and very large. The filing of reports-114 million different varieties for the federal government alone—by itself is es­timated at $40 billion per year. This does not include the resources con­sumed by the government in pro­cessing the reports. Both costs, of course, are passed along to the con­sumer/taxpayer. There is no one else to pay them.

The resources consumed in this production of paper are not avail­able to help satisfy other wants in our society, of which there are plen­ty. But the economic losses extend beyond the immediate out-of-pocket costs for the grinding out of official documents. The price-fixing edicts of the I.C.C. have ripple effects that extend to the immediate waste of time and energy, to the depletion of reserves, to malinvestment, to mas­sive misplacement of populations, urban blight, and environmental degradation.

Estimates of the direct costs of waste in transportation vary from a low of $4 billion to a high of $16 billion per year. The rat hole into which this money is poured consists of: (1) the inefficient use of truck transportation—possibly as much as 40 per cent of truck miles are driven empty of cargo due in large part to I.C.C. rules restricting entry into various markets, and this does not include the wasted circuitous miles that must be driven under ab­surd “gateway”¹ rules, (2) the inef­ficient use of rail transportation—compulsory service on low-volume, short haul lines constitutes a major portion of waste in underutilized capital investment; (3) the diversion of traffic from rails to roads—I.C.C. price fixing designed to protect the trucking industry prohibits railroads from lowering fares to take advantage of their lower costs.

Senseless Waste

How can this waste possibly be justified? What’s the point of all this regulatory nonsense? Who benefits by such policies? Osten­sibly, the whole process is designed to protect the public from the evils of a nonregulated environment. Yet, economists have for the most part conceded that there are no net aggregate benefits of the regulatory scheme in transportation. The con­sumer ends up poorer with an an­nual dead loss of billions of dollars. Those who do gain by the regula­tions do so at the expense of everyone else. Surface shippers other than railroads have been vociferous advocates of the status quo. Water carriers have the benefit of publicly maintained rivers and canals for which they pay no use fees. Highway freight haulers holding “certificates of public con venience” have the benefit of publicly maintained roads for which they are paying less than their share of the costs.²

The net effect of the transporta­tion policies of the I.C.C., then, is to transfer wealth from the general public to the trucking and water carrier industries. In addition there are certain depletions of natural resources—trucks use four times as much fuel to move the same weight of goods the same distance as railroads—and degradations of the environment via the production of extra air pollutants by the less effi­cient trucks. All of this is presumably justified as “socially beneficial,” as a necessary price to pay for the preservation of “fair” competition in transportation.

What advocates of this position fail to comprehend is that serving human needs is not a game—it is a serious business of survival. The ob­jective is not to give selected par­ticipants in the provision of services a chance to “win,” but rather to maximize the satisfactions that can be gotten from a finite supply of resources. The economic environ­ment by its very nature is prone to “unfair” competition; some firms can attain significant advantages in cost reduction over their rivals. Such a sequence of events is known as progress. In short, the painstak­ingly constructed vision of “fair” competition upheld by the I.C.C. is essentially arbitrary and based on the fallacious belief that all substantive developments in the technology of transportation have already taken place. Policies based on such a vision insure stagnation and flirt dangerously with disaster.

Rude Awakening

The elements of waste that we have described thus far may be just the tip of the iceberg in terms of the massive distortions programmed into our economy via the uneconom­ic pricing of transportation. There is no gainsaying that millions of business decisions affecting virtual­ly every aspect of our material well-being have been influenced to some degree by the irrational pricing system of transportation regulation. The attempt to circumvent reality has thrown an element of miscalculation into a multitude of investment choices. When the illu­sions can be maintained no longer, the dream world will end and, like it or not, we will experience a rude awakening.

This rude awakening will come in the form of rapid transformation of capital assets into malinvestments. Malinvestment occurs when re­sources cast in the form of nonliquid capital goods can no longer produce values to justify their cost. Such assets, consisting of build­ings, roads, machinery, and the like, cannot be fully converted to alter­nate uses. Much of the materials and all of the effort invested in their original creation become total write-offs. More than a century of mistaken transportation policy has influenced the business decisions that have shaped the contemporary environment. So the fantasy world of idyllic “fair” competition becomes more difficult to maintain, the necessity for readjustment edges nearer. The prospective pain of the readjustment produces more frantic, more absurd efforts to forestall the inevitable. Examina­tion of the scope of the malinvest­ment will clarify the impending dislocations.

The attempt to impute a uniform cost for transportation by the mile has led to an undercosting of the disadvantages of remote location. Low density, remote areas have received enormous subsidies in terms of highway construction and the maintenance of underutilized rail outlets over an extended period of time. Meanwhile, centrally located urban areas have lost a por­tion of this advantage as the excess charges on shipments to these points have been used to subsidize losing routes. This process, while not the total cause, has facilitated the exodus from the city.

A Dispersed Population

This dispersal of population and industry has had its part in the creation of some familiar contem­porary phenomena. Most notably these have included urban decay through the loss of the tax base, traffic jams and automobile pollu­tion via the subsidized roadways, and a bland homogenizing of life style as more and more every place is becoming like every other place. Perhaps such consequences are desirable from a social benefit standpoint, but they are unrealistic from an economic standpoint and cannot be sustained indefinitely.

Dispersal of population to more remote areas has raised the trans­portation costs of the nation both in the form of accelerated consump­tion of energy to move goods across greater distances and in the estab­lishment of excess capacity in low utilization of rail and highway facilities. At the same time, the price for the use of these resources consumed has been held below a market level. Admittedly, the I.C.C. has only been one participant in the process; fuel price lids and overbuilding/undercharging in the highway construction program have played important roles as well. The classic effects of such a policy are portrayed in any elementary text on economics. Artificial shor­tages are created as demand spurred on by the low price out­strips supply deterred by the poor returns.

Where Do We Go From Here?

In spite of the serious problems fostered within the regulated transportation industry, few pro­ponents of remedial action are prepared to adopt a rational approach. Proposals tend to fall into one of two categories. First, there are the faint-hearted advocates of reform of the existing system. These “patch and smooth-over” plans seem oblivious to the critical defects of the existing regulatory process—the result of political maneuvering in complete ignorance of basic economics. Such plans in­clude the current Amtrak system which still runs large deficits even after being relieved of substantial fixed costs for right-of-way maintenance. Likewise, a recent proposal to finance Conrail and other railroad subsidies via a two cent increase in the tax paid for fuel by trucks, trains, barges, and air­craft is bereft of economic logic. All such plans seek to elude or subvert economic laws of supply and de­mand. Consequently, they can only serve to worsen the problem.

A second line of reasoning arrives at the conclusion that since rail­roading is a “sick” industry it ought to be nationalized and run by the government. Subjecting even a healthy industry to the quack med­ications of nationalization would be likely to produce a terminal illness. To advocate this prescription for an industry already suffering from the ministrations of regulation is the equivalent of treating anemia by bleeding the patient. Government enterprise in this country has been marked by the twin evils of deter­iorating service and rising costs. The subsidies applied to keep these enterprises operating serve only to increase the market distortion by siphoning off resources from suc­cessful satisfiers of consumer needs in order to reward waste and ineffi­ciency.

Plans formulated to negate the verdicts of market action rest firm­ly on two outstanding fallacies. First, that government experts can determine the needs of consumers better than can the consumers themselves. Losses experienced under policies based on this fallacy are then blamed on the consumers who failed to recognize the “needs” they neglected in order to satisfy some other “whims” of their own. Second, that the primary economic problem of society is distribution. The problem of production has been solved, proponents claim, yet “social needs” go begging because the distribution system is flawed by its reliance upon prior production as the source of claims upon economic resources.

Unfortunately, the problem of production has not been solved. Resources are not inexhaustible and effort is required to meet material needs. This is as true of the provi­sion of transportation as of any other economic good. If we are go­ing to channel scarce resources into the “social need” to maintain unused rail lines and drive empty trucks on circuitous routes over ex­pensive highways, then we are go­ing to be channeling these scarce resources away from other needs. Scarcity, page one in the fundamen­tals of economics, is the reality.

A Plan For All Seasons

Given that scarcity is a fact of life, how are we to make the most of what we have? Utilization of the profit incentive has provided substantial achievements in loosen­ing the bonds of scarcity. True, it is not the only motivating force con­ceivable, but it has, to date, proven more effective than its next most frequently used substitute—fear of punishment. Application of the pro­fit incentive to the issue of transportation policy suggests that the most effective long-range plan is deregulation.

Deregulation would maximize the flexibility of the transportation system to adapt to consumer de­mand. At the same time costs could be expected to decline as the necessity to operate at a profit, or at least break even, forces the ineffi­cient out of the business. Among the benefits to be anticipated would be the elimination of red tape and delay in adjusting rates and routes to consumer needs, the elimination of bureaucratic costs incurred in the futile attempt to regulate a complex industry in a dynamic environment, the reduction of waste as noneco­nomic services are trimmed back totally or to self-supporting levels, and an improved atmosphere for in­novation and progress as efficiency translates into corporate profits.

With all these beneficial pro­spects, it is still considered improbable that deregulation will en­joy much support in policy making circles. Among the reasons fre­quently cited are the sunk costs of current operators in the truck and barge industries. It is generally con­ceded that railroads would stand to be net gainers in traffic if allowed to compete on the basis of price. Thus, barge and truck owners whose pro fits are predicated to a degree on present prohibitions of rail competi­tion stand to lose some of their revenues. However, such an argu­ment based on protecting the in­terests of these firms cannot justify the perpetuation of waste which the consumer must subsidize.

A second line of reasoning asserts that “the public” demands the con­tinuation of uneconomic services. This is inherently contradictory, for if the public demanded³ a service it would be provided without government compulsion. What this line of thought is leading to is that there may be some individuals who would like to have the benefits of a service without being willing or able to pay the going price. Resolution of this disparity between desires and means through the provision of certain services in-kind, like subsi­dized Amtrak traffic, is plagued with several critical defects.

First, policy makers have no way of knowing what the actual demand for a given service might be as they tamper with the market.

Second, as the outlay of expen­ditures are awarded to one industry after another the lobbying for such subsidies becomes more intense. At the same time, allocation of scarce capital becomes distorted as uneconomic enterprises take on positive returns on investment, thus diverting funds from other businesses that may have offered services to more urgent needs.

Finally, as a welfare scheme for those unable to meet the market price, it is woefully inept. The selec­tion of services to be provided is ar­bitrary and the benefits unevenly distributed amongst rich and poor alike. So, if concern for those too poor to afford the market prices of any goods or services is our object, an income maintenance program would seem more to the point. Beyond this, the claim that “the public” demands uneconomic ser­vices is without merit—the result of naïveté or cynical manipulation of public policy for personal gain.

Chaos or Monopoly Expected in Absence of Regulation

A third, and more serious, argu­ment against deregulation concerns the notion that regulation is all that stands between a vulnerable public and chaos or monopoly in the transportation industry. What con­stitutes chaos may be a matter of individual perception. For sure, unregulated markets are subject to a greater degree of fluctuation, but this is evidence of one of their prime advantages—the ability to adapt quickly to a dynamic environment. This adaptability is more in tune with the real world than the mea­sured deliberateness of regulatory tribunals whose actions are often obsolete before they are ever enacted. In fact, the major part of our economy is still dominated by transactions in which the govern­ment plays no direct part in deter­mining prices or market shares of the participants.

The argument from chaos or monopoly has to hinge on the assumption that transportation is different in some significant way from other industries. This assumption is that transportation is a “natural monopoly” or is prone to monopoly. The reasoning has a cer­tain amount of plausibility. After all, only one set of railroad tracks can occupy a given space. Com­petitive parallel tracks would, on first examination, appear redun­dant and wasteful. But everything enjoys a monopoly of some space or other since no two things can exist in the same space at the same time. On first examination, competition in any endeavor might appear re­dundant. Yet, we don’t ordinarily view it as such. The fact of the mat­ter is that any freely operating market is infested simultaneously with examples of monopolies as well as competitors.

Perhaps the claim of monopoly is based upon the type of service of­fered by transportation. The con­sumed product in this case is place value. What the purchaser seeks is to transport himself or goods to another location. With this as his objective, though, it would appear that there are a number of different ways to accomplish the end desired. It is. difficult to conceive of a cir­cumstance where one transporta­tion company would enjoy a com­plete monopoly of the means of transport between any two loca­tions. In the final analysis one could always walk and hand carry goods to new locales—the universal method that pre-dates all modernization of transport from the domestication of beasts of burden to the development of interplane­tary travel. What people are care­lessly calling monopoly, then, is something else. Based on compara­tive advantage between modes, one transportation firm may be the mode of preference for all or substantially all traffic between two points.

Conditions Vary

Comparative advantage is not unidirectional. At times and for various reasons, trains may be preferred to trucks or vice versa. It would be normal for specialization to develop to the point where the preferred mode enjoys substantial advantages over any alternative. For example, it seems reasonable that rails would be the most feasible means of moving copper ore out of a pit mine in Arizona. Does this constitute monopoly? Would the cop­per producer be “at the mercy” of the railroad owning a single track to the mine?

Effectively the answer is no. We no longer live in an age where giant business organizations are domin­ated by single personalities direct­ing corporate policies on individual whim. The depersonalization of the business enterprise does have its beneficial effects. Roadbeds are an expensive asset. Unused, they deteriorate over time due primarily to weather. Unlike a hundred years ago, railroads can no longer expect to extract preferential treatment from the government. Gone are the days of massive land grants as a source of Federal subsidy. Rail­roads today must make the best use of their assets. It is in their in­terests to maximize the rate of return on their capital. This cannot be accomplished by shortsighted at­tempts to charge the absolutely highest rate possible.

Low Volume Hurts

Since the assets depreciate whether used or not, low utilization of railways penalizes the railroad in the same way that high vacancy rates penalize the owners of rental space. The copper mine has to main­tain its own rate of return on invest­ment lest they run themselves out of business by giving away a de­pletable asset. The amount that it can and will pay for shipment of ore is limited by the constraint to achieve a minimum return on as­sets. Should the circumstances of low ore prices or high transport costs or some other factor reduce the rate of return below an accep­table level, the traffic on the rail lines could well fall to zero—wiping out the stream of revenues flowing from that rail asset. The railroad’s asset will depreciate more rapidly through lack of use than the mine’s major asset. Ore can be stored in the ground where it’s been buried for millions of years. Roadbeds for the railroad cannot be expected to last quite as long.

Obviously then, the mine is not “at the mercy” of the railroad. Both operations enjoy rather a symbiotic relationship where the interests of each are served in the efficient transport of ore to its destination. Thus, we have considered an ex­treme case. As we move toward situations of greater substitution of one mode for another the elements of competition add diversity to the ways in which common business problems are solved. As we roll down the track from the pit mine to the trunk line, to the switching yards, to the major interchanges, the options multiply to a wide varie­ty of ways to get from here to there. Likewise as we move on to other cargoes the number of carriers in­creases enabling us to select the one best way of moving our goods to their destination.

Transportation is not a natural monopoly. Railroads, assuredly, be­ing but one mode in the transportation industry are nowhere near a monopoly. Gone by the boards are all the major arguments for main­taining the regulations now im­posed on the industry. What is left are the ill defined fears of what might happen under deregulation. Based upon the smooth transac­tions of ordinary business in other industries, it seems extremely unlikely that the exaggerated fears of opponents of deregulation will bear even a remote chance of com­ing about. However, should some of these fears show signs of develop­ing, it will always be possible to devise specific remedies applicable to the situations that arise. Argu­ments of opposition to deregulation based on what took place in the years prior to 1887 and the establishment of the I.C.C. seem fun­damentally irrelevant today. The entire economic environment has changed and along with it the political situation which fostered many of the ancient abuses imputed to the rail industry.

Simple, Yet Flexible

Any rail plan can be beautifully simple, yet retain the flexibility to deal instantaneously with the dy­namics of fluctuating needs. Dereg­ulation would provide the best overall solution to transportation’s problems. Nothing’s perfect, of course, and there are bound to be many complaints issuing forth from such a plan. Nevertheless, the ob­jective has to be to facilitate the maximization of benefits from limited resources. Free entry and exit to the industry, flexible rate and route structures all hold forth the promise of more efficient service to the consumer with less waste. Funds currently misspent in main­taining the current transportation scheme will be released for use in some of society’s more pressing needs.

 

—FOOTNOTES—

¹Gateway rules require a carrier to travel over specified routes regardless of the origin or destination of the freight.

²In 1969, the Federal Highway Administra­tion estimated that truckers users’ fees were $219 million less than the costs attributable to their use.

³1n economic terms, demand involves two factors: (1) that a consumer is willing to buy and (2) that he is able to buy. If either of these factors is absent, demand does not exist. For example, if a service is selling for $100 any given consumer may not exert demand if (1) he feels the price is too high—lack of willingness to purchase, or (2) he doesn’t have the money—lack of ability to purchase.

—SELECTED BIBLIOGRAPHY—

“Bitter Battle Over the Penn Central’s Value,” Business Week. (October 27, 1975). “Can the ICC Sidestep Rail Rate Flexibility?” Industry Week. (May 31, 1976).

The Crisis of the Regulatory Commissions.

New York: W.W. Norton & Company, 1970. “Discussion of Papers on the End of Economic Regulation,” Transportation Journal. (Spring 1976).

“Economic Case for Deregulating Trucking,” Business Week. (November 2, 1974). “Failings of Regulation,” Michigan State University Business Topics. (Spring 1976). “Fast Work Needed to Forestall Rail Line Abandonments,” Harvard Business Review. (May 1975).

“Florida East Coast Railway Case: a Study of Governmental Decision-making,” Labor Law Journal. (March 1974).

“Freedom From Regulation?” Business Week. (May 12, 1975).

“How Much Intramodal Competition?” Railway Age. (April 26, 1976).

“How to Run a Railroad,” Harper’s. (Decem­ber, 1975).

“ICC Redesigns Rail Rescue Plan,” Business Week. (April 28, 1975).

“ICC’s Collision Course with Rail Manage­ment,”Business Week. (July 6, 1974).

“Introducing Price Indexes for Railroad Freight,” Monthly Labor Review. (June 1975).

“Market Dominance Test: the 1976 Act’s New Approach to Railroad Rate Regulation,” Transportation Journal. (Summer 1976).

“More Aid from Taxpayers for Bankrupt Railroads,” U.S. News and World Report. (March 3, 1975).

“Multibillion Plan to Save Sick Railroads,” U.S. News and World Report. (March 10, 1975).

“Rail Transit and the Building of the American City,” Railway Age. (July 4, 1976).

“Railroads Deserve Liberty,” National Review. (July 4, 1975).

“Rate Bias Against Recycling,” Business Week. (December 22, 1973).

“Regulation, Public Policy, and Efficient Pro­vision of Freight Transportation,” Transportation Journal. (Fall 1975).

“Right to Compete,” Railway Age. (July 4, 1976).

“Spook Words: Proposed Nationalization,” Nation. (March 29, 1975).

“Straightening Out the Rails,” Environment. (September 1975).

“Study Criticizes Way Regulators Are Chosen,” Industry Week. (May 10, 1976).

“Surface Transport: Middle of the Road Solu­tion, ” Harvard Business Review. (November 1975).

“Third Curse of Moses: Bureaucracy and the Death of the Railroads,” Vital Speeches. (November 1975).

Throttling the Railroads by Clarence B. Car­son. Irvington, N.Y.: The Foundation for Economic Education, Inc., 1971.

“Track Record,” New Republic. (January 26, 1974).

“Trucking Overhaul: Motor Carrier Reform Act,” Time. (November 24, 1975).

“Why a Bill of Rights for Railroads?” Railway Age. (July 4, 1976).