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

connects.



The Exceptional Importance of Fixed Charges in the Case of

Railroads



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

standards.




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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

Producers



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

Charges



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



Not

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.




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A Simple Case of Special Costing Applied to Certain Traffic



We

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.




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

Cost



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.




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A Principle governing Competition between Railroads and Carriers by

Sea



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

railroads.




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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.




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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.




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The Standard of Freight Charges under a Regime of Monopoly



A

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

Lines



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

secured.



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.




A---------------------------B

A'

]



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

Favored



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

Costs



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

Fields



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

themselves.



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



It

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

Transportation



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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