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The Foregoing Principles Applied To The Railroad Problem

Simple Cases of Charging "What the Traffic will Bear."--The value of
a study of primitive carriers and their policy lies in the fact that
it illustrates principles which apply to transportation by a
complicated system of railroads, although in this latter case they are
not easily discerned. Imperfect competition is what exists in the
department of carrying. So long as a railroad is without any rival it
may, in some cases, charge for moving goods from one point to another
about as much as the cost of making them at the latter point exceeds
the cost at the former. This is the simplest case of charging what the
traffic will bear. Or, again, the situation may be dominated by
producers at a third point who can make goods and get them carried to
the place we may term the market for less than the cost of making them
directly in this latter place. In such a case the road may demand
nearly the amount by which the cost of making the goods at an
accessible third point and moving them to the one which is their
market exceeds the cost of making them in the place first named; and
this is a slightly less simple case of charging what the traffic will
bear. It is appropriating the difference between two natural values
neither of which the railroad itself fixes.

Charges based on Various Kinds of Cost

The charges of the
railroad may be limited by the competition of inferior carriers who
use its own route, such as teamsters whose wagons use a public highway
running parallel to its own track. Here charges are based on costs,
but not on those which the railroad incurs. They are the costs which
the teamsters incur; and if the railroad has much business, its own
costs are less and it makes a profit. The charges may be based on
costs incurred by more economical carriers, like owners of ships, and
in such a case the rate which the railroad can get may be less than
its own costs, if these are figured in the simple way of dividing a
total outlay by a total number of units of freight transported. The
rate is based on the shipowners' costs, and these are so low as to
bankrupt the railroad if it should reduce all its charges to such a
level. It reduces them thus only on the particular route where
competition by water is encountered, and keeps them elsewhere at the
higher level. In the case of shipments by rail over such routes "what
the traffic will bear" is determined by the low charges established by
the ships; and this means that it is determined by a certain definite
cost of carrying goods between the very points which the railroad

The Exceptional Importance of Fixed Charges in the Case of

The railroad, in the case just noticed, carries its rates
below costs, as these are computed in a simple way, but keeps the
lowest of them somewhat above the variable costs which we have
defined; and there appears the important fact that the fixed costs
incurred by the railroad form an unprecedentedly large part of its
total expenses. The interest on the outlay it makes for roadbed,
track, bridges, tunnels, terminals, etc., is something for which
there is no fair parallel in the case of wagons or ships. This is the
first unique fact concerning railroads and their policy; and the
second is that they continue very long in that intermediate state
which we have illustrated by the ship which had only a partial cargo
and was impelled to take some traffic at a special and low rate. For
many years the railroad only partially utilizes its plant; and so long
as that is the case its natural policy is one of drastic
discrimination between different portions of its business. A third
great point of difference between the railroad and other carriers
appears if, while its capacity is still only partially utilized, it
encounters the direct rivalry of other railroads that are eager for
business; competition then takes a shape which impels the participants
irresistibly into some kind of combination. The union may be tacit or
formal, and it may depend on personal relations or on some merging of
corporations; but toward something that will make the rival lines act
concurrently and with mutual toleration the situation impels them with
unique force.

The general features of railroad rates, then, are--

(1) Some charges based on the difference between the natural value of
merchandise at the point of origin and its value at the point of
delivery, as this latter value is determined by causes independent of
the rates charged for transportation between the two points;

(2) The adjustment of other charges according to costs incurred by
independent carriers operating between the same points;

(3) The exceptional importance of the railroad's "fixed costs" and the
drastically discriminating rates to which this leads;

(4) The irresistible motive for combination where direct competition
appears between railroads connecting the same points.

We speak of the condition of railroads as an intermediate state
because it is one out of which a natural development takes other
carriers when their capacity for service is fully utilized. The same
cause--a complete utilization of the plants--would have a like effect
in the case of railroads; but the cause is so slow in coming into full
operation that few persons think of it as affecting the problem at
all. The problem of freight charges on railroads is usually regarded
as if the intermediate state were destined to be perpetual. It is,
however, entirely true that a full utilization of the plants of
railroads would tend to take them out of this state. If the increase
of business came after a combination had been effected, it would tend
to put a stop to the sharp discriminations to which the eager quest
for traffic has led. Different shippers could more easily secure
equally favorable treatment. Freight of a low grade would be less
desired, since the space it would require might otherwise be available
for business of a more profitable kind, and the rates on such freight
would rise. The increased traffic would make it possible to earn large
dividends without increasing charges on the lower grades of freight,
and while greatly reducing the charges on the higher grades; but no
economic force would be available for securing this adjustment. The
state, by positive regulation, might secure it and might bring the
earnings and the charges of the railroads more or less nearly to the
normal standards which prevail where competition rules; but if
competition were here to begin, it would result quite otherwise. It
would restore the old condition of partially utilized cars, track,
etc., and cause a new strife for traffic, which would cause some
freight to be taken at very low rates, but would lead to inevitable
consolidation and higher charges.

In general industry competition tends so to adjust prices as to yield
interest on capital, wages for all varieties of labor, including labor
of management, and nothing more, and this is the outcome elsewhere
demanded by a growth of business coupled with a theoretically normal
and perfect action of competition; but the peculiarities of
competition between railways do not bring about the evolution which
would give this result. Combination is effected long before the
returns from the total traffic are made normal and before the returns
from different parts of it are brought into their legitimate relation
to each other. After the union of rival companies, railroads continue
to be in that intermediate state in which the effect of an unused
capacity for carrying has its natural effect in charges which
discriminate widely between different localities and between different
kinds of freight. The railroad traffic does, indeed, begin to follow
the course which we have illustrated in the case of transportation by
water. It takes a few steps in that direction, but further progress is
then stopped by combinations.

The fundamental laws of economics still apply. The static standard of
freight charges exists, and one can form some idea of what actual
charges would be if the forces which elsewhere tend to bring prices to
their theoretical standards could here operate unhindered. The
hindrances, however, are such as definitely to preclude such a result.
The rates do not become in a true sense normal. Even under such
active competition as at times exists they do not become so, while
without competition they never tend to become so. It would, however,
be a gross mistake to assume that static standards have no application
whatever to railway transportation. The whole subject is most easily
understood when those standards are first defined and the baffling
influences which prevent actual rates from conforming to them are then
separately studied. There are influences which bring the various
charges of railroads within a certain definable distance of normal





The situation of railroads we take as we find it--one of complete
consolidation in case of many roads, and of harmonious action, or

quasi-consolidation, in the case of others. In general their charges
are fixed by the place value they create, as that value is established
by influences other than the charges themselves. It might seem that
the charge for carrying fixes the place value. Whatever a railroad
demands for carrying goods from A to B measures the enhanced value
which they get in the moving; but if they would have possessed at B
the same value that they now have, even though the railroad had not
existed at all, it is evident that it is this value minus the value of
the goods at A which fixes the charges for carrying, rather than that
these charges fix the place value. We have seen in very simple and
general cases how this principle works, and have now very briefly to
trace the working of it in the case of a system of railroads. The
special method of reckoning costs to which we have referred is an
important element in the process.

"Costing" comparatively Simple in the Bookkeeping of Competing

In the study of ordinary industries we have encountered
conditions which render the bookkeeping of a producer simple and cause
him to charge all his costs, in a pro rata fashion, to his entire
product. If his goods and those of his rivals are of one kind and are
sold in a single market, a cut in the price of any one portion of the
product involves a corresponding cut on the entire output. It is not
possible to single out any particular increment for a reduction of
price and leave the rate unchanged on the remainder. Where products
are of different kinds it is possible to make a classification of them
so as to get a large profit on some, a small one on others, and none
at all on still others. When competition has not done its full work,
something of this kind happens in many departments of business. A
condition of unequal gain from different portions of an output lingers
long after some effects of competition have been realized. In the end,
however, it must yield if competition itself does its complete work,
and whenever we adhere heroically to the hypothesis of the static
state, we preclude this inequality of charges. Rivals who contend with
each other for profitable business bring the prices of the goods which
afford the most gain to such a level that a mill which makes this type
of goods will pay no more in proportion to its capital than one which
makes other types. The total cost of production, fixed and variable
alike, would at that time, as we have seen, be barely covered, and
might correctly be apportioned in a pro rata manner among all parts
of the product.

The Effect of Increasing Business on Comparative

Competition of this perfect kind does not exist in
manufacturing and is far from existing in the department of carrying,
and it is important to know whether with growing business and greatly
tempered rivalry there is any tendency toward the equalization of
charges and the simplifying of the mode of reckoning costs. When a
mill has more orders than it can fill, those it wishes to be rid of
are the ones which yield the smallest profit. They encumber the mill
and prevent the filling of more profitable orders; and the natural
mode of reducing the amount of this undesirable part of the output is
to raise the charges on it. This comes about without much aid from
competition, for when all producers find their capacity overtaxed,
they have no motive for contending sharply for business. Underbidding
has for its purpose attracting business from rivals and is an
irrational operation when all have orders enough and to spare.
Competition is largely in abeyance when the business any one can have
is overabundant.

These Principles Applicable to Carrying

What we here assert
concerning goods manufactured by independent mills would be true of
goods carried by independent vessels, if they plied between the same
two ports with no intermediate stops. If their capacity should at any
time be overtaxed, they would not reduce the charges on higher grades,
but they would raise them on the lower grades, and the classification
of freight would lose some of its significance. The lowering of the
charges on the high grades of freight would come when the profits of
the business should attract new carriers, who would naturally seek for
the traffic that paid the best, till all kinds paid about alike. The
mode of reckoning costs might then become simple--a pro rata
division of total outlays among all parts of the business.

The Condition of Uniform Costing never realized upon Railroads

a single one of the essential conditions of equalized charges and
uniform costing is now realized upon railroads, and there is only one
of them that is approximated. Separate markets for different parts of
the traffic are provided by the nature of the business. Every point to
which goods are conveyed furnishes such a distinct market, and the
service of carrying goods to it is paid for by a distinct set of
customers. It follows, therefore, that some rates can be cut without
affecting others, and they regularly are so. The second condition,
that of bringing the carrying capacity of railroads into the fullest
possible use, is attainable, but it is very remote. At times there is
a congestion of freight and, in general, the capacity of existing
plants is more nearly used than it heretofore has been; but by an
addition to the rolling stock they could carry more than they do and
the additional traffic would cost far less than the portion already
carried. Moreover, with no addition to the rolling stock, very
considerable enlargements of traffic could at many points be made.
Thirdly, competition between railroads is not at present effective
enough to bring about a reduction of the higher charges and make
returns and costs simple. Combination takes place long before the
discriminating charges are abandoned. Low-grade freight continues to
be carried side by side with the high-grade which pays better. Charges
to terminal points continue to be low, while charges to intermediate
points are high. In a sense one may say that a tendency to discontinue
these practices exists, but it is a tendency that is so effectually
resisted that its natural results are only in small part realized. If
a dam is built across a reservoir, holding the waters on one side ten
feet above those on the other, one may say that the waters have a
tendency to reach a uniform level, since the power of gravity is
exercised in that direction; but the dam baffles the tendency. And so
in railroad operations something interferes which checks the force of
competition or removes it altogether, long before the discriminations
in freight charges are removed or very much reduced.

An Intermediate State made relatively Permanent

As we have said,
the condition of traffic on railroads is analogous to what in the case
of manufacturers and primitive carriers would be regarded as a
transitional state soon to be left behind; but in the case of
railroads it is relatively permanent. It is the condition in which
certain natural economic forces are working vigorously, and, if they
were not counteracted by other forces, would end by making natural
adjustments and establishing normal rates for the carrier as well as
the manufacturer. In this intermediate state the natural forces are
counteracted and the adjustments are never made, and what we have to
study is the degree in which they are approximated.




A Simple Case of Special Costing Applied to Certain Traffic

will suppose A and B are connected by a railroad, while C and B are
connected by a highway over which transportation proceeds by the
primitive means of horses and wagons. It is like one of the cases we
have already stated, with the exception of the fact that the carrier
over the longer route is a railroad. The limit of what the railroad
can get is the natural difference between the cost of making the goods
at A and the combined costs of making them at C and carrying them to
B. This definitely limits the railroad charges. Whatever difference of
cost there is the railroad can get if it chooses, and barring any
deduction it may make in order to induce production at A and make
traffic for itself, it will get it. The rate which is fixed for the
railroad may be sufficient to cover the total costs chargeable to this
portion of its traffic on the simple and pro rata plan of costing,
or on the other hand, it may cover only a portion of the fixed costs
or no portion at all. This means that the standard which is set by the
differing values of the goods at A and at B may or may not yield a
profit to the railroad. If it is so slight as not to cover even the
variable costs of carrying the goods, the railroad will not carry
them, and the supply will be allowed to come from C rather than from
A. If it covers more than these variable costs, the road will accept
and carry the goods. If the traffic affords any appreciable margin
above the variable costs, it will be the policy of the railroad to
make its charges low enough to attract the traffic, and this will
slightly reduce the place value of the goods at B and bring it below
the cost of procuring them from C. The railroad will thus secure the
whole traffic to the exclusion of that which came from C. If the costs
of making the goods at A and C are alike, then the charge for carrying
from A to B will be just enough below the total costs of carrying in
wagons from C to B to stop the carrying over this shorter route and
appropriate the whole business; but this charge may not cover total
costs of carrying from A. It may yield only a slight margin above the
variable costs attaching to this part of the railroad's business. It
thus appears that this carrier can with advantage accept the freight
at a rate that by a perfectly normal bookkeeping is below cost, while
the teamsters on the road from C cannot do this.




A Second Case in which Carrying is done for Any Amount above Variable

Let us now suppose there is a railroad from C to B as well
as one from A to B. There is now competition between makers at A
and carriers from A to B, on the one hand, and makers at C and
carriers from C to B, on the other hand; and whichever of these
quasi-partnerships delivers the goods at B at the cheaper rate gets
the whole traffic. By the terms of our supposition the makers in both
places are offering goods at cost, and any cutting of rates that is
to be done must be done by the carriers. To reduce the prices of the
goods at the mills in either locality would put some of them out of
business. We will assume that there is no consolidation and no other
means of concurrent action between the railroads, and that the whole
traffic will thus go to the route over which the lower rates are made.
For simplicity we will still adhere to the supposition of equal costs
for manufacturing and of unequal costs for carrying. As the charge for
carrying goes down, one or the other of the railroads will reach the
point where the variable costs of this traffic are barely covered,
while on the other line they are more than covered. Where rivalry is
not tempered in any way whatever, the charge made by competing roads
falls to a level at which returns only cover the variable costs
incurred by one of the competitors, though it may return somewhat more
in the case of the other.

How Fixed Costs are Met

This implies, indeed, that the fixed
charges of both roads must somehow be met by the returns from other
traffic; and this supposition is in accordance with the facts. A
freight war may temporarily carry rates to a level where some traffic
does not cover variable costs and where total traffic falls short of
covering total costs. Such a situation cannot long continue, and the
natural adjustment, under active competition, is one at which rates on
the traffic for which the two lines are contending are just below the
variable costs incurred by one line but above those incurred by the
other. There is nothing to prevent the stronger railroad from thus
reducing its rates, attracting to itself the whole of the traffic,
and putting an end to the rivalry of the other line. This would mean
bankruptcy for that line unless it had other sources of income.

The Effects of Bankruptcy on Costs

Bankruptcy means a scaling down
of the fixed charges of the railroad to such a point that the total
traffic can meet them; but it does not enable the company to reacquire
business that will not yield enough to cover variable costs. Adhering
to the supposition that there is no mutual understanding, no pool, and
no other approach to consolidation between the rival lines, we may
safely say that the general rule which elsewhere governs rates holds
true here. Two roads actively competing for identically the same
traffic tend to bring charges to a level at which the variable charges
entailed by this traffic on the one route are not quite met and the
traffic passes to the other line.[1]

[1] If we wish to vary our supposition that the cost of
making the goods at A and at C is the same, we have a
modification of the case we have stated. If it is much
cheaper to make them at A, the railroad that carries these
goods from there to B may charge more for carrying than does
the one that delivers the goods made at C. It is possible
that the difference between the costs of making at the
different points may tell decisively in favor of the longer
route, and it may be the railroad from C to B that first
reaches, in its charges, the level of variable costs and
sees its traffic handed over to its rival.




A Principle governing Competition between Railroads and Carriers by

In a third case there may be between A and B a railroad and a
water route also, while between C and B there is a railroad only. On
the supposition we have made,--that competition between carriers by
water has done its full work,--the charge for carrying anything by
water from A to B must be sufficient to cover a pro rata part of the
total costs. That may be sufficient to cover the merely variable costs
entailed on the railroad, or it may not. If it does not, the railroad
will not take any portion of the business except what it may take by
reason of the greater speed with which it can transport the goods. If,
however, the total costs of carrying by water exceed by a tolerable
margin the merely variable costs of carrying by land, the railroad
will be able to take the traffic. If this traffic goes to the water
route, the charge made by the railroad from C to B is adjusted by a
simple rule. This railroad can get the natural difference between the
cost of the goods at C and the cost of similar ones made at A and
carried by water to B. If the railroad gets the traffic between A and
B, and the water route is abandoned, the case becomes the same as that
which we have already considered,--the transporting is done at a rate
which prevents one of the lines from covering its merely variable
costs and secures all the traffic for the other line. The carrying
from A to B goes by land or by water according as the variable costs,
in the one case, or the pro rata share of total costs, in the other,
are the less; and nothing can be carried from C to B unless it can be
delivered at B at a price as low as that of goods made at A and
transported at the rate just described. If the costs of making at A
and C are equal and there are the three carriers seeking traffic, as
assumed, the result naturally is to give all the business to the one
who will bid the lowest for it. Either railroad will bid as low as the
variable costs which the traffic occasions; while the owners of ships
will bid no lower than the rate which covers costs of both kinds.[2]

[2] If carriers by water are in that intermediate state in
which their capacity is only partially used, they also may
offer to take some traffic for an amount which only covers
variable costs; but this condition does not naturally become
in their case semipermanent, as it does in the case of


The Case of Railroads having Common Terminal Points

In the fourth
case there are, besides the other carriers, two railroads between A
and B which compete for the traffic at these terminal points, but not
at intermediate ones. Their facilities for through traffic are alike.
The local traffic on the different lines is unlike, since it is
affected by the character of the regions through which the railroads
pass; but the charges made for local traffic are governed by the
comparatively simple principles which we first stated. In contending
for freight to way stations we may say that the railroad has to
compete with wagons upon the highway, but with nothing more efficient.
The charges for local freight may therefore be extremely high, while,
if the railroads are really competing as vigorously as pure theory
requires, and if the normal results of competition are completely
realized, the rate which can be maintained between A and B for any
articles carried will be no higher than those which cover the variable
costs entailed on the route which is the less economical of the two.
The line to which this test assigns the traffic between A and B must
then stand the further tests we have described--those involved in
contending for business with carriers using respectively the water
route and the railroad from C to B.

A Condition leading to a Reduction of Fixed Costs

It is safe to
assume that one of the two railroads from A to B has more local
traffic than the other. It may be that even with this advantage its
total returns of all kinds may fall short of covering its total
outlays. In that case the total returns of any less favorable route
must fall still further short of the amount necessary for covering all
outlays; and if we adhere to the assumption that neither consolidation
nor anything resembling it takes place, we have a case in which both
railroads must undergo reorganization. The fixed charges of the better
route must be scaled down and the creditors of this railroad must
accept the loss, while on the other route the fixed charges must be
reduced still more and the creditors must suffer a larger loss. It
goes without saying that the prospect of such a calamity means
consolidation. It is evident what alternative competitors face in
cases in which heroic competition goes on to the bitter end. As a rule
this is an unrealized alternative. The mere prospect of the calamity
connected with it is bad enough to put an end to the independent
action of the different railroads. With the facilities for combination
which now exist a far smaller inducement suffices to bring this about.



The Case of Railroads whose Entire Routes are Parallel

We have to
consider only one more typical case in order to have before us a
sufficient number to establish the general principles which govern the
charges for the carrying of freight by railroads. Variations
innumerable might be stated; and, indeed, the experience of the
railroad system of this country affords the variations and reveals the
results which follow from the conditions they create. The railroads
may be strictly parallel lines, pursuing the same route and competing
for local traffic as well as for through traffic. If the case we
lately examined insures consolidation,--and indeed all of the cases we
have stated impel the companies powerfully toward it,--this last case
makes assurance doubly sure. Strictly parallel railroads competing for
traffic over their entire routes and neither uniting nor showing any
of the approaches to union would be an impossibility. Persistent
competition would then mean reducing all charges to the level fixed by
variable costs, which would leave no revenue whatever to cover fixed
costs, and would send the companies into a bankruptcy from which even
reorganizations could not relieve them, since they could not
annihilate all the fixed costs.

A Case of Arrested Development

It is clear that, in the entire
policy of railroads, the fact that their capacity has never been fully
used plays a highly important part. It makes the distinction between
fixed costs and variable ones a leading element in the adjustment of
charges. With the capacity of railroads completely used, as is that of
a ship which carries a full cargo at every voyage, the distinction
would lose most of its importance. More business would then require an
addition to every part of the plant and would thus entail new fixed
costs which would have to be charged against the new business. As the
traffic of any railroad grows toward its maximum, the cost which each
separate addition to it entails grows larger and larger. When cars are
few and are only half filled, an increment of traffic entails a very
small increment of expense. When the cars are filled and new freight
requires the purchase of more of them, the cost of this addition to
the traffic becomes greater. When further additions to the freight
carried require additions to trackage, yard room, storage room, etc.,
they cost far more than the earlier additions; and new increments of
freight come, in the end, to cost very nearly as much per unit as the
general body of the previous traffic when all outlays were charged
against it. The railroad approaches the condition of the full ships
referred to, in which further cargoes require further ships, with all
the outlays which this implies. The distinction between different
kinds of costing is gradually obliterated, and railroads steadily draw
nearer to that ultimate state which other carriers more quickly
approach, in which each part of the freight carried must bear its
share of the total costs entailed. Long before that state is reached,
however, combination ensues, and the movement of freight charges
toward their static standard is arrested.




The Standard of Freight Charges under a Regime of Monopoly

consolidation so complete that it would merge all rival lines under a
single board of control and pool all their earnings would restore the
early condition described in connection with one of our
illustrations--that of the single railroad between A and B, having
only sailing vessels and wagons as rivals. It is able to charge what
the traffic will bear in a simple and literal sense. The consolidated
lines can, if they choose, get for each bit of carrying the difference
between the value of goods at the point where they are taken and their
value at the point where they are delivered. These values are
approximately what they would be if no railroad existed. The carrying
done by the railroad itself does not enter into the making of them.
The natural value of a commodity at A is what it costs to make it
there, and the value at B is either the cost of making it at B, or
that of making it at C and carrying it in wagons to B, or that of
making it at A and carrying it by water to B. In any case there is a
natural and simple process of fixing the costs both at A and at B, and
the difference between them is the limit up to which the railroad can
push its charges if it will. Where the business which furnishes the
freight is not fully developed, the railroad may moderate its charges
for the sake of letting it grow larger. The hope of increased traffic
in the future may cause a reduction of demands in the present. We
shall see what other influences may keep the charges below their
possible level; but the natural difference between two local values of
goods is the basis of the charge for carrying them from one point to
the other. Consolidated lines, if they had as perfect a monopoly of
carrying by railroad as has the single line in our illustration, would
base their charges on this simple principle, though for a number of
reasons they might not take all that the principle would allow.

How Imperfect Consolidation Works

Imperfect consolidation, when it
follows a period of sharp competition, has to deal with obstacles
which prevent a complete carrying out of this policy. Many rates have
become far lower than the rule of monopoly would make them, and there
are difficulties in the way of raising them. A weak combination of
parallel lines may keep its charges within bounds, partly from a fear
that larger ones may afford too great an incentive to secret rate
cutting and may so break up the union, and partly from a respect for
what the people may do if the exactions of the railroads become too
great. The more complete forms of consolidation have not the former of
these dangers to fear; and if, without being restrained by the state,
their charges continue moderate, it is mainly due to the fact that
other lines less firmly consolidated are unable safely to make a
radical advance of rates, and that this often prevents such a course
in the case of lines which would otherwise be able to take it.

Limits on the Charges of a System of strongly Consolidated

This means that where a great system of railroads occupying
the whole of a vast territory is so firmly consolidated as to have a
complete monopoly of carrying by rail within the area, it is still
affected in indirect ways by the possible rivalry of lines altogether
outside of its territory. An excessive charge on freight from Chicago
to New York might induce carrying by rail from Chicago to Norfolk and
thence by water to New York. It might cause grain, flour, etc., to be
shipped to Europe from Southern ports rather than from those on the
Atlantic coast. These cases and others do not fall under principles
essentially different from those already stated, but they call for the
application of the same principles in complex conditions which our
study is too brief to cover. There is a supposable case in which
nearly all that could be secured by any railroad connecting Chicago
with the Atlantic coast, even though every line in the territory
between them were the property of one corporation, would be the
variable cost of carrying goods over a line running to a port on the
Gulf of Mexico. Reflection will easily show how the principles already
stated apply to this case and others.

Effects of a General and Strong Consolidation

With all the lines
in this country and Canada in a strong consolidation, the advance of
rates to, or well toward, the limit set by the principle of natural
place value created would inevitably come unless the power of the
state should in some way prevent it. The railroads would be able to
get the difference between the cost of goods at A, in the illustrative
case, and the cost of making or procuring them at B without using the
connecting line of railroad. When the appeal to the state is only
imminent,--when the power of the government is not yet exercised, but
impends over every railroad that establishes unreasonable
charges,--the rates may be held in a fair degree of restraint. A
wholesome respect for the possibilities of lawmaking here takes the
place of actual statutes. A respect for the law appears in advance of
its enactment and may amount to submitting rates in an imperfect and
irregular way to the approval of the state. This effect, when it is
realized, is to be credited in part to laws which will never be
enacted. The merely potential law--that which the people will probably
demand if they are greatly provoked, but not otherwise--may be a
stronger deterrent than the prospect of more moderate legislation. In
general a considerable part of the economic lawmaking of the future
will undoubtedly be called out by demands for action that is too
violent to be taken except under great provocation. The dread of the
extreme penalty insures a cautious policy in increasing charges which
have been established under a transient regime of competition. Partial
monopolies adhering to rates many of which were established under the
pressure of competition--such are the railroad systems of America. The
existing condition shows some of the effects of competition which has
ceased and of legislation which has not taken place. As the
combinations shall become greater and stronger, the situation
everywhere will become more and more akin to that which existed in a
local way when a single line of railroad had no effective competition,
and the charges which the traffic would bear were fixed in the way we
have described and absorbed the place value which the carrying
created. It is a method which exposes the public to an extortion
which, though not unlimited, is unendurably great. Consolidation,
therefore, means the control of rates by the state; but it is
essential that this control be exercised with due regard for the
economic principles which rule in this department of industry. Thus
only can there be secured the results of a natural system unperverted
by monopoly.

The principles which a study of simple cases suffices to establish are
as follows:--

1. Freight charges are essentially a variety of price. They express
the exchange value of place utility.

2. The static standards or norms toward which these prices tend are
fixed in the same way as are other static standards of value,--by a
rule of cost,--though in the case of railroads the working of this
rule is exceptional.

3. When carrying is done by simple means and by competing carriers,
the ultimate basis of charges is the cost of the carrying; and this is
estimated in the simple way in which, under perfectly free
competition, the cost of making commodities is estimated. The total
outlay is charged against the total product.

4. A single railroad between one point and another, when it is not
affected by the rivalry of any other railroad, can get for its service
the difference between the cost of goods at the place where they are
made and the cost at the point of delivery, on the supposition that
they would either be made at this point or carried thither by more
primitive means. Under such a partial monopoly the costs incurred by
the railroad itself do not directly set the standard of its charges,
but other costs do so.

5. In this case the so-called variable costs incurred by the railroad
furnish a minimum limit below which its charges cannot go, but to
which they tend to go in the case of traffic which cannot otherwise be

6. This place value which the railroad can confer on the goods is
small (1) when the cost of making the goods at their place of
departure is not much less than that of making them at their place of
destination, or (2) when it is not much less than the cost of
obtaining them from a third point, or (3) when it is possible to carry
them from the place of their origin to their destination by water or
by any other cheap means of transportation.

7. Variable costs are positive additions to the total outlays
previously incurred by a railroad, and they result from adding a
definite amount to its previous traffic. They are less than
proportionate parts of total costs, including interest, some part of
operating expenses, cost of maintenance of roadway, etc.

8. The comparative smallness of the variable costs is chiefly due to
the fact that the carrying capacity of railroads is only partially
used. These costs become relatively larger as traffic increases, and
would practically coincide with proportionate shares of total costs if
the traffic should reach its absolute maximum.

9. If the place value above defined is large enough to cover the
variable costs attaching to certain traffic and afford any surplus
whatever, the railroad usually takes this traffic.

10. On the business which it gets the charges vary widely and, as it
appears, capriciously, but they are at bottom governed by the economic
principle stated--that of place value as established in ways in which
the charges of the railroad itself do not figure.

11. Competing railroads tend to bring rates downward toward a minimum
which is fixed by the merely variable costs of the carrying as done
by one or more of the railroads themselves.

12. The competition between railroads is arrested while they are not
using their full capacity, while the merely variable costs of an
increment of traffic are still abnormally low, and while many rates
are so.

13. Railroads which compete for freight between terminal points are
strongly impelled toward consolidation; and those which compete along
their entire lines are forced to resort to it.

14. Consolidation in its more imperfect forms tends to establish rates
that are abnormally high, but this tendency is somewhat checked by the
danger that the combination may be broken by a desire to foster
business in a section of country and by the indirect influence of
lines outside of the territory controlled by the consolidated roads.

15. In its stronger and more extended forms consolidation leaves the
people with no adequate safeguard against extortionate charges except
as this is furnished by the intervention of the state; and this needs
to be effected with an intelligent regard for the natural forces which
are at work amid the seemingly capricious irregularities in the
present system of charges.

The Aim of Regulation by the State

An aim of a government, in all
of its economic policy, is to insure the best use of the national
resources, and this can often be done by keeping alive free
competition. Where the rivalry of producers is active, a law of
survival guarantees that the more economical method of producing an
article shall displace the inferior one. When the choice lies between
using a quantity of free and disposable labor in making goods in a
certain market and using it in making them elsewhere and carrying
them to the market, the alternative which gives society the most that
it can get by any use of its productive resources is the one that is
spontaneously selected.

How an Extortionate Local Charge may sometimes be reduced without
Injury to a Railroad

A low charge for freight carried from A to B
coupled with an extortionate one from A' to B might preclude making
the goods at A', though they can be made there at excellent advantage
and the interests of society will soon require that they be so. This
situation can exist only so long as traffic is slight between A and A'
and greater between A' and B. The growth of traffic over the former
section of the route will make it desirable for the railroad to raise
its rate over that portion. If, under compulsion or otherwise, it
reduces the rate from A' to B sufficiently to permit the production of
the goods at A', it will gain a profitable traffic between A' and B at
the cost of giving up a relatively unprofitable one between A and B.


Variable Costs a Proper Basis for Some Charges

It makes for
general economy to pay respect to the distinction between fixed and
variable costs and let much freight be carried for anything it will
yield above the variable ones. If ten units of labor are required for
making an article at B and only five at A, and if a railroad between
these points, whose capacity is not fully utilized, can carry the
article from A to B with an expenditure of two additional units of
labor, then society can best get the goods for use at B by spending
these seven units in the making and carrying. It would take ten units
to make them at B, and to society itself there is a saving of three
units from making them at A and carrying them at a special rate to B.
Till the railroad is more fully used for other purposes this source of
economy will continue. Though the rates charged for this freight would
bankrupt the railroad if they were applied to its entire traffic, it
is best for the railroad to take this special bit of carrying at any
rate exceeding the wages of the two units of labor; and for the time
being this is the best way to use some of the social resources, since
it gives at the point of delivery and use more goods for a given
outlay than could have been had in any other way.

Why Consumers may suffer while Particular Producers may be

It will be seen that this principle affords an inducement
for making a special classification of certain goods and carrying them
for less than merchandise of a generally similar kind is carried for.
It is a policy of "making traffic" which costs little and is worth
more than it costs both to the carrier and to society. This incentive
for reducing charges does not operate as strongly in the case of goods
carried to consumers who are forced to live on the route. They are
held there by the general causes mentioned at the beginning of the
preceding chapter, and must pay the tax which the railroad imposes on
them. The only limit on this tax is the possibility of otherwise
procuring the goods or of moving out of the territory. The ultimate
possibility that population may not grow under a regime of extortion
and that both freight traffic and passenger traffic may be held within
small limits imposes some check on the railroad's exactions. The
company may find it worth while to foster to some extent the growth of
population; and to favor producers of certain goods in order to
induce them to locate their establishments on its line, and the result
of this may be good for society; but there is no way of securing a
general good from the heavy tax on the rest of the traffic unless this
has been necessary to insure the existence of the railroad itself. In
that case there may be a temporary necessity for it, which will
disappear as traffic grows.

The Policy of the State in Dealing with Low Charges based on Variable

The interest of railroads which have a monopoly of their
routes is to advance the rates on through traffic. We have noticed a
possible case in which some equalization of charges by occasional
reductions of local rates takes place. An increase of charges over
long routes not made necessary by any pressure of business which
overtaxes the railroad's carrying power would of course be injurious.
Moreover, carrying full loads does not constitute such an overtaxing
as calls for the higher rates. There are times when present supplies
of cars and engines may not be able to move more freight than they do;
but in that case more of them are called for. Only when the point is
reached at which providing for this through traffic in addition to the
local freight entails additions to the permanent plant and involves
costs that exceed the return from the through business, is it
justifiable, in the interest of social efficiency, to advance such
charges. In preventing such an advance under other conditions a
government helps to secure an approach to a natural economy and a
maximum of production.

When, in the Interest of General Productivity, a Reduction of Local
Charges is called for

We saw that carriers of a primitive kind
competing with each other would put every charge, local or otherwise,
on a basis of its proportionate share of total costs. The traffic as
a whole would return enough to cover all the outlays, and each part of
it would yield its share. This is the ideal of effectiveness for
railroads, as well as for ships and wagons. The attainment of the
ideal without a regulation of charges by the state is never to be
expected. One feature of this normal condition is that, where no
special improvements have recently been made, total returns should
just equal total costs, in the sense in which terms are used in static
theory--that sense in which all interest charges and all expenses of
management figure among the costs. No net profit for the
entrepreneur, but full interest for the capitalist and full wages
for all varieties of labor, is the rule that gives the static measure
of normal returns. If a state shall slowly reduce the charges for
local freight, while holding unchanged those for through traffic,--all
the while allowing the total returns of the railroads to cover what we
have defined as total costs,--it will do all it can toward securing an
approximation to the condition which affords the largest product of
social industry. It will help to make the resources of the people do
their utmost in yielding an income. Total returns covering all costs,
a reduction of those charges on local traffic which have prevented
industries from springing up at intermediate points between favored
centers, a gradual increase of local production without any positive
repression of production elsewhere--such are some features of the
general change which the future should bring and which only the power
of the state can make it bring.

How the State may secure what Competition secures in Other

In general industry the rivalry of entrepreneurs carries
prices to a level fixed by costs, but in transportation the rivalry
has so largely disappeared as to prevent such an outcome. The state
cannot restore much of the vanished rivalry and would cause an
unnatural condition if it did so. We have seen toward what an abnormal
level of costs a sharp "freight war" carries rates. What the state can
do is something which an instinctive judgment of the people is
impelling it to do; namely, to adjust rates directly and bring them
gradually toward the standard to which competition, if it were working
as it elsewhere works, would automatically bring them, namely, that at
which wages and interest are fully covered. A surplus above these
outlays could always be temporarily secured wherever a special economy
had been effected, and the source of legitimate profit would be open
to carriers as it is to producers generally. How much should be
reckoned as interest depends on the question how the capital itself is
estimated, and here again the instinct of the people has been correct.
It will not accept as a measure of true capital the market value of
all the stocks and bonds the railroad has issued. The quotations of
the market make the total values of the stocks and bonds equal a
capitalization of its total earnings, and these may include a profit
due to monopoly. If a state were to figure the capital in this way,
and then so adjust rates as to allow ordinary interest on the sum thus
computed, it would merely leave total returns as they are. It might
change comparative charges, but not the sum total of all of them.

How Capital should be Estimated

In that static condition in which,
as we have shown, capital is as productive in one subgroup as in
another, the capital is first measured by the cost of the goods that,
in the inception of the industry, embody it, and in static studies
this cost is regarded as constant. Returns from different outlays are
equalized, and a dollar invested in one kind of business then yields
as much in a year as a dollar in any other. In a dynamic state the
cost standard still prevails, and as the tools of production become
cheaper, in terms of labor, it takes more of them to represent the
same amount of capital that was originally invested. What it would at
any time cost to duplicate every item in the equipment of a business
measures the capital it uses. Nothing but a failure of competition in
the case of railroads prevents the application of this standard to
them. Monopoly makes earnings more or less independent of sums
invested and causes purchasers to buy stock at rates that are
independent of costs of plant and equipment and are fixed by earnings

The Process of Estimating Capital on the Basis of Cost

If we
undertake here to do by public authority what competition elsewhere
tends to do, we shall have to restore the standard based, not on the
original cost of the railroad's substantial property, but on the cost
of getting another that would be equal to it in working efficiency.
The plant is worth what it would naturally cost to duplicate it; and
an average rate of interest on that sum is the natural return from it.
There are ethical claims which are entitled to respect and which
preclude any sudden reduction of the value of a railroad's properties;
and, moreover, the end in view can be attained in a way that will not
necessarily take anything from the absolute amount which they are now
worth. If the amount of dividends remains fixed, the increase in the
actual value of the plant itself will bring these dividends into the
proper ratio to it. The land that the companies use is becoming more
valuable. Measured by what it would cost to duplicate it, it
represents a larger and larger amount on the companies' inventories.
If the equipment also is enlarged as traffic grows, the entire sum on
which interest and dividends are computed becomes continually larger.
If the interest and dividends earned by the plants now in existence
remain fixed in absolute amount, they will become a smaller and
smaller percentage of the real capital of the companies. Merely
letting railroads earn the amount that they do at present would bring
the net incomes after some years to the same rate--the same percentage
of invested capital--that the income from other capital represents.
New plants and enlargements of old ones should be allowed to earn
enough to furnish an incentive for providing them as fast as the needs
of the public require it.

How Insuring a Fixed Amount of Total Earnings would affect the Rates
charged for Freight

It goes without saying that the general
increase of traffic, while the freight charges remain the same,
increases the net earnings of the carrying companies. Therefore the
policy of keeping the net earnings at a fixed total amount would mean
a reduction of rates for freight and passenger service. We do not here
raise the question how much reduction will be required for the purpose
in view--that of transferring to the people at large whatever now
constitutes a genuine monopoly profit. In the case of some lines there
is, it is safe to say, no such profit, and it will be impossible to
tell how much of it elsewhere exists till some careful appraisal of
plants and equipments, on the basis of the cost of duplicating them,
shall have been made. What we need to know is that, by the aid of such
an appraisal, the state can, if it will, secure in the department of
carrying the result which is automatically secured elsewhere, namely,
the prevalence of charges which afford normal returns on invested
capital as well as wages for every kind of labor.

Elements of the Problem not included in a merely Economic Study

will not fail to occur to any reader that in making the present study
of railroads a very general and purely economic one we leave out of
account some facts of great importance. We take no account of
corruption within the corporations which do the carrying, nor of
corruption in the relation between them and the officials of the
state. Stockholders within the corporation are likely to have their
interests betrayed by those who are appointed to take charge of them,
and citizens of the state are likely to have their greater interests
betrayed, in a like manner, by their appointed custodians. We cannot
here discuss the various plans by which directors plunder their own
corporations, nor the ways in which public officials betray the
people. All of these abuses are disturbing influences in the economic
system; and all of them interfere with the adjustment which gives the
highest productive efficiency, and contribute a full share toward
putting the social order in danger. All are, however, so obviously
criminal, if they are judged by the spirit of the law,--not to say by
the letter of it,--that it is better to leave the discussion of the
mode of suppressing them to legal and political science.

A Practical Mode of Insuring an Approach to Normal Rates for

When competition rules, it enlarges the supply of a
dear article till the price of it is normal, and it increases the
capital in a profitable business till its earnings become so. In the
case of railroads this does not automatically take place, but the
result of it all--adequate service and normal charges for it--can be
directly secured by the state. Charges that have been made reasonable
by competition may be left as they are, and those that are
disproportionately high may be gradually lowered. The growth of
traffic may be trusted to keep the total earnings of the companies'
present plants at the amount at which they now stand, in spite of
these reductions of rates; and enlargements of the plants may be
permitted to earn further sums which will attract capital and keep the
service abreast of the public need. All this will require expert skill
of a very high order. For the purpose of the present work it is enough
to say that such a course as this is the only one which will insure in
transportation the results which competition elsewhere yields. It will
secure both rates and service which the civil law calls "reasonable"
and economic law calls "natural."

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