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ployment of more men.

Movement expenses, including the wages of engi-
neers and roundhousemen, the cost of fuel and water
for locomotives, of the train service and train sup-
plies, and expenses of a similar nature are variable.
They depend upon the amount of the work done.
The more freight to be moved the greater the expense
of moving it. Movement expenses fluctuate with
the amount of business, although even here we may
notice that while in a broad way a reduction of traffic
will compel a reduction in the number of trains, the
expenses for engine and train service upon a particular
train will be the same whether it be empty or full.

Conducting transportation upon the average rail-



UNDERLYING PRINCIPLES



17



road in the United States in recent years takes about
forty-two per cent of the total expenditures ; of
which, roughly speaking, one-third may be allotted
to constant, and two-thirds to fluctuating expenses.
Using this examination of the outgoings of a
railroad as a basis, we may prepare a table separat-
ing expenditures into those which are constant and
those which are fluctuating. The following table so
arranges the figures already obtained but, like the fig-
ures themselves, is rather an illustration of the princi-
ples involved than a statement of technical accuracy :



Class of Expenditure.


Proportion of

Constant

Expenses to

Total
Expenditures.


Proportion of

Fluctuating

Expenses to

Total

Expenditures.


Fixed Charges.

General Expenses.

Maintenance of Way and Structures.

Maintenance of Equipment.

Conducting Transportation.


25

3

10

7
14


6

7
28




59 -1- 41 = 100



The conclusion therefore follows, that a clear ma-
jority of the expenses of a railroad are independent
of the amount of its trafiic. This is fundamental.

Here is a corollary to the conclusion just reached :
The expenses of a railroad are not apportionable to dif-
ferent items of traffic. As expenditures

, ... . . . Joint cost.

have no certain relation to business done,

they largely constitute joint and not separable cost.

With the exception of a small portion of the disburse-



1 8 AMERICAN RAILROAD RATES

ments, which may be broadly divided between pas-
sengers and freight, most 'of the outgoings of a
railroad are for the benefit of the service as a whole
and not for any part of it.

Fixed charges manifestly are not apportionable.
Expenditures for maintenance of way and equipment,
with the exception of the small amount spent upon
passenger stations or freight houses, cannot even be
allocated to freight or passenger traffic — much less
to any particular item of traffic. Expenses for
maintenance of equipment may to a limited extent
be apportioned between the freight and passenger
service, but no further. Expenditures for conduct-
ing transportation may also, through a dissection of
accounts, be assigned in large measure to either
freight or passenger traffic, but the apportionment
ends there. Attempts to apportion expenses to pas-
sengers and freight according to train mileage rest
upon an entirely arbitrary basis.

Even if it were possible to allot all expenses to
the passenger and freight traffic respectively we
should only meet the impasse of joint costs a little
later. Considering the freight service by itself —
and the same is true of the passenger service — the
energy is expended with reference to the work as a
whole, and not with regard to any particular part.
The constant expenses are absolutely non-appor-
tionable. The fluctuating expenses are in great part
incapable of separation, and those which may be
dissected can only be apportioned with the greatest



UNDERLYING PRINCIPLES 19

difficulty. The transportation of any article involves
the use of terminal facilities, road-bed, and train, and
the service of many different departments. Expen-
ditures to meet these expenses — joint costs — are
not assignable to any part of the traffic.^

Even in the case of a single freight train there is
a large element of joint cost. While it might be
possible to determine the out-of-pocket expense
of running the whole train a stated distance, it would
be utterly impracticable to calculate the expense of
transporting any particular part of the goods upon
the train. There would be one joint cost for the
whole train load, and it would ordinarily be difficult
to show that any single item cost anything at all.
Only in the case of a train loaded with a single article,
e. g. coal, would it be possible even to approximate
the cost per ton mile, and the cost so determined
would only represent the money out of pocket.

We shall later see how joint costs necessarily
affect the making of rates.

Here is another corollary to the conclusion that
the expenditures of a railroad are largely independent
of the amount of its traffic : When constant ^ ^ . .

Law 01 in-

expenses have been paid^ additional business creasing
shows an enhanced percentage of profit. The ^^^"^"^•

^ Returning to the canal again we find a perfect illustration of an
establishment furnishing various services at joint cost. With the ex-
ception of the small expenditures for maintenance and supervision the
only expense is interest on the permanent investment. All expenses
are for the benefit of the traffic as a whole and go on whether the busi-
ness be heavy or light.



20 AMERICAN RAILROAD RATES

total cost does not increase in proportion to the In-
crease in the volume of business. Conversely, the
net income increases more rapidly than the business
expands. A railroad is subject to the " law of in-
creasing returns " — the principle that increase in the
production of an industry within the capacity of the
plant results — prices remaining the same — in an
increased ratio of profit upon the capital.

A railroad is seldom operated to the extent of
its capacity. Its cars, tracks, and locomotives are
generally capable of greater service. Traffic up to
a certain point pays the constant expenses. Beyond
that point, and up to the capacity of the road and its
equipment, the cost to the railroad company is only
the expense which varies with the traffic. We have
seen that the constant expenses of a railroad are
more than half the total expenditures. If, therefore,
— as shown by Mr. Acworth ^ — "it costs x to deal
with 1,000,000 units of traffic, 5,000,000 units will
cost, not 5 X, but >^x+(^xx5) = 3 x."

Increase in business enables the railroad to charge
lower rates. An expanding volume of traffic may
profitably be carried at continually lowering prices
until the capacity of the railroad and equipment be
reached. But when the increased business neces-
sitates additional facilities it may cost more than it
is worth. The single track road may operate to its
maximum with increasing profit. The expense of

^ The Elements of Railnvay EconoTtiics. By W. M. Acworth.
London, 1905, p. 50. An admirable little book of high authority.



UNDERLYING PRINCIPLES ii

Jaying another track may entail more in interest
charges than the increased business will pay.

Declining rates from outside causes — competition
or business conditions — may more than offset the
benefit of the law of increasing returns. While an
increased business may be handled more economically
per unit of traffic, and, in consequence, a railroad
be enabled to reduce its charges to th^ extent per-
mitted by the saving in expense, it can seldom sub-
mit to a larger reduction without loss. If it make
a greater reduction it may be ruined not only in the
face of, but on account of, a constantly increasing
traffic. The more business done at a loss the greater
the loss.

The converse of the proposition, that an increase
in the business of a railroad makes for lower rates,
is also true. Reduced rates stimulate traffic. The
lower the charge the more business. But the extent
to which traffic may be developed by the most radical
reductions in rates is limited. In the case of very
valuable articles the freight is proportionally such
an inconsiderable item that a reduction has little effect
upon their movement. In the case of articles already
in very general use- — the necessaries of life — only
a limited increased demand could be expected if
rates were made nominal. And this is not all. The
possible traffic from a given territory is limited by
its productivity. The railroad cannot carry more
grain from the Western station than the surrounding
district will produce, if it carry it for nothing. Re-



12 AMERICAN RAILROAD RATES

gardless of rates, no more ore can be obtained from
the mining town than the mines will yield. More-
over, productivity limits incoming as well as out-
going shipments. The farmer cannot buy more dry
goods than his grain will pay for, no matter how
cheaply they may be carried. Rate reductions may
have far greater effect upon one road than another,
depending upon the potential traffic. Nothing will
be gained by reducing rates unless there is something
to be gained.

A railroad is an economic monopoly in many
places.^ Most localities have only a single line and
Railroad as are without Water communication. Here
a monopoly, f-j^gj-g }g j^q guch thing as Competition.

The possibility of building a parallel line is of little
benefit to the shipper. If not a capitalist he can-
not build, and if he is, the building proposition is
likely to be unattractive. Traffic sufficient to enable
one railroad to pay large dividends may not be

^ "John Stuart Mill long ago called attention to what we may call
economic or industrial monopolies where competition is neither illegal
nor shut out by nature, but where it is shown to be practically ineffi-
cient and undesirable. . . . Certain characteristics are common to
them all. The industry demands a large amount of capital ; it supplies
a necessary of life ; the article furnished is local ; the industry occupies
a peculiarly favorable situation ; the methods of operation require unity
and harmony of management 5 the production can be largely increased
without a proportional amount of capital. This is true not only of
docks, water-works, and gas-works, but of all media of transportation
— turnpikes, canals, telegraphs, post and railways." From a most
valuable article by Professor E. R. A. Sellgman, entitled " Railway
Tariffs and the Interstate Commerce Law," in Political Science
^arterly, 1887, Vol. II.



UNDERLYING PRINCIPLES 23

enough for two to make any dividends. Moreover,
a new road can compete with difficulty with an es-
tablished line. As we have seen, the more business
a railroad does the cheaper it can do it. The old
road with two or four tracks and large tonnage can
make lower rates than the single track road with
small tonnage.

A railroad is 2i partial monopoly in places having
a single road and water communication. The water
route can reach few places directly, and often necessi-
tates transshipment and delay. It seldom gives
the shipper precisely the service he desires. A rail-
road is 2i part o/'an economic monopoly where there
are several railroads which unite in a division of
the business.

A railroad is ^practical monopoly, from the point
of view of the small shipper, even in those places
where there are competing roads. He is not in a
position to bargain. He cannot deal on even terms.
He must pay the rate charged by one of the rail-
roads or not ship his goods.

Now while monopoly is the opposite of compe-
tition, and while without competition the laws of
trade cannot operate, it does not follow that a rail-
road monopoly is injurious to the public. Industrial
competition tends to low and equal prices. Rail-
road competition, as we shall later see, generally
tends to discrimination and unequal rates. Rail-
road monopoly — its opposite — ought to lead to
low as well as equal rates, and this because the rail-



24 AMERICAN RAILROAD RATES

road is subject to the law of Increasing returns. If
one railroad between two cities be able to attend to
all present traffic and have room for more, how is
the public benefited by the construction of another
road ? One road, with the increasing profits attend-
ing an increased business, should either give the
public better facilities or lower charges. If it will
not do so voluntarily it should be compelled to do
so by public authority. Two roads dividing the
traffic may be obliged to keep up charges and econo-
mize in facilities in order to make anything at all.
The railroad should be recognized as a monopoly
and treated as such.

A monopoly under governmental supervision may
better promote the public interest than the freest
competition. But it must be closely watched.
How closely, is the important question. Govern-
mental regulation cannot become governmental
control without a shifting of responsibilities.



CHAPTER II

LIMITATIONS OF RATES

The obligations of a railroad, and the economic
principles governing Its business set limits to the
charges which It may make. Limitations apply to
rates collectively and Individually — to tariffs and
separate charges. A railroad Is entitled to receive
from all the rates together enough to pay expenses
and a fair return upon capital Invested. It Is not
entitled to receive more because It Is fulfilling a
public function. And because It is fulfilling a pub-
lic function each and every charge It makes must
be reasonable.

A railroad has the right to adopt a schedule of
rates which will produce sufficient revenue to afford
a reasonable return upon the value of Its ^ .„

^ Tariffs

property. The stockholders and bond- should af-
holders who furnished the means for build- turn upon "
Ing the road cannot be deprived of a just "p^*^^-
reward for their enterprise. A law having that ef-
fect would be unconstitutional. A tariff Is reason-
able which will produce In the aggregate a fair return
upon the value of the railroad property. Economi-
cally, a railroad should not charge more. Legally,
it cannot be required to accept less.^

1 See Chap. IX.



26 AMERICAN RAILROAD RATES

In determining the value of the property of a
railroad upon which it is entitled to a fair return,
the matters to be given weight are

(i) The original cost of construction.

(2) The amount expended for permanent im-
provements.

(3) The estimated expense of duplication.

(4) The par and market values of stocks and
bonds.^

The original cost plus the amount spent for im-
provements theoretically represents the cost of the
road. But while both elements are to be considered
in ascertaining the value of the property they do not
necessarily reveal its true worth. Some railroads
have been economically built and honestly managed.
Others have been extravagantly constructed and
inefficiently controlled. Some were built when
wages and materials were high and some when they
were low. Cost alone is no criterion of value. If
applied as a standard it would generally make the
result too small, because railroad accounts rarely
show all the earnings spent in construction.

The cost of reproduction has sometimes been
taken to represent the value of a railroad. In
theory it does represent actual value. The diffi-
culty, however, with basing value upon the esti-
mated cost of duplication, arises from the practical
impossibility of estimating the "incidentals" — an
item of importance in large undertakings. Making

1 See the Nebraska Rate Case, 169 U. S. Rep. 546.



LIMITATIONS OF RATES 27

cost of reproduction the criterion of value would
almost necessarily produce a result unfairly low.

If stocks were not watered and capitalization
fairly represented money invested, the par value
of the outstanding stocks and bonds of a railroad
would fairly represent original cost and the expense
of improvements not met from earnings. A con-
venient basis for ascertaining value would be fur-
nished. But stocks are watered. Anticipated profits
are capitalized in advance. A large volume of
securities is deemed desirable for speculative pur-
poses. Fictitious capitalization, however, is not an
element of value, and the amount of outstanding
stocks and bonds is seldom a true measure of
worth. A railroad cannot by the manufacture of
paper securities impose upon the public the burden
of making them pay real profits.

The market, rather than the par, value of the
securities of a railroad measures the value of its
property. Property ordinarily is worth what it
will sell for. The prices of a railroad stock, how-
ever, fluctuate so widely with speculative move-
ments that it is difficult to say that the price at any
one time represents true value. Average prices are
better. The mean market prices of railroad securi-
ties for a substantial period furnish the only indica-
tion of the value of railroad property, available in
the absence of the most searching examination.

The earning capacity of a railroad fairly indicates
its value for many purposes. Property is often



28 AMERICAN RAILROAD RATES

rated according to what it brings in. But earning
capacity cannot determine the value of the property
of a railroad upon which its rates must make a fair
return. Earnings are dependent upon rates, and
value indicated by earnings manifestly has no rela-
tion to the reasonableness of rates. Otherwise, the
more the railroad charged and thereby earned, the
more it would have the right to charge.

What the fair return is which a railroad is entitled
to receive cannot be determined by the application
of any fixed standard. It must vary with the period
and with the conditions. It should be sufficient and
only sufficient to lead to the continued investment
of capital in railroads. Rates should be so adjusted
that the total revenue produced by them will com-
pensate the railroad to the extent that the same
amount of energy expended in other branches of
productive industry is compensated.

But all this has very little to do with particular
charges. The value of the railroad property is
only important in determining the reasonableness of
an entire schedule of rates, — an inquiry which can
hardly arise except when a law-made tariff is attacked
as being confiscatory and, therefore, unconstitu-
tional. The value of the property is a most remote
consideration in fixing an individual rate. While
each shipment should undoubtedly produce its
^-millionth part of the revenue required from all
shipments, x is an unknown and unknowable quan-
tity. It would be impossible to fix even the maxi-



LIMITATIONS OF RATES 29

mum or minimum of individual rates in any such
way. In the long run the schedule should bring in
a fair return upon capital invested, but the necessity
for such return has practically no effect upon the
charge for the particular service. We must look
for other factors to determine the individual charge.

Individual rates have a maximum and Maximum
minimum fixed by two principles: mm^of^

(i) A charge for any transportation ser- charges,
vice cannot exceed the value added by that service.^

(2) A charge for any transportation service cannot
go below the expense which would not have been
incurred had the service not been rendered.

The value added by the service necessarily fixes
the maximum rate. When commodities have a
market value in one locality greater than in another
the value to the shipper of transporting them from
the one place to the other is the difference in price.
Transportation creates value to the extent of the
difference. A charge, however, which is greater
than the value created will stop shipments.

The principle of value created by transportation
is clearer in the statement than in the illustration,
on account of an apparent transposition of cause
and effect. The market price of a bushel of wheat

1 The phrase " value of service " as used with respect to railroad
charges has two shades of meaning. In an exact sense, it expresses the
value created by the transportation service. In a broader sense — and
including the narrower meaning — it embodies the principle that ability
to pay a rate measures the value of the service of earning the rate.
We shall later fully consider the value principle in rate making.



30 AMERICAN RAILROAD RATES

may be a dollar in New York and ninety cents in
Chicago, but this difference is caused by the charge
of ten cents per bushel for transportation from
Chicago to New York. The difference in price
does not produce the rate. The rate produces the
difference in price. Raising the rate will not stop
shipments but will raise the New York price. But
this is only true because Chicago supplies New
York with wheat. If the price through raising the
rate should be made so high as to attract wheat
from other world markets, the value which could be
added by the transportation service would be defi-
nitely marked and the rate definitely limited. To
illustrate further: If the rate from Chicago added
to the price there fix the price of a bushel of wheat
in New York at a dollar, a wheat grower in the
South West, who can get eighty cents per bushel for
his wheat for shipment to Europe by way of Gal-
veston, cannot afford to pay more than twenty cents
a bushel to ship to New York. If the railroad
desire the business it must meet the value of the
service with the rate.

While the principle that the maximum charge
for any service is the value added by it is more
readily applicable in the case of commodities which
have regular market prices, it is of general applica-
tion. No man will pay more for any service —
transportation or otherwise — than it is worth to
him. Traffic cannot be charged beyond its ability
to pay. If it is it will not move. The difference



LIMITATIONS OF RATES 31

between the worth of the service and the charge
measures the inducement to shipments.

The out-of-pocket expense fixes the minimum
charge. A rate cannot be made lower than the
additional cost of rendering the particular service.
The extra outlay must be compensated for or the
railroad will be the loser by doing the work. A
railroad may cut rates to develop business, but it
must obtain from each item of traffic at least suf-
ficient to pay the expenses which would not have
been incurred had that traffic not been handled.
No conditions can justify a lower charge. But it
is urged that losing rates are defensible when given
temporarily in order to stimulate industries and
build up paying business at particular localities
— that future profits may more than offset present
losses. This might be true if the railroad carried
on a strictly private business. It could take such
hazards as it saw fit. But, while it may do busi-
ness without profit, its public obligations forbid it
to impose upon one locality the burden of making
up the actual losses sustained in favoring another.
It cannot speculate at the expense of the public.

The maximum rate, therefore, is fixed by what
the shipper can afford to pay ; the minimum, by
what the railroad can afford to carry for. But these
limits are wide apart. Where between the two ex-
tremes the particular rate shall be placed depends
upon many circumstances. In a general way it may
be governed by the policy of the railroad. One



32 AMERICAN RAILROAD RATES

management may believe that low rates develop
business, and seek for small profits on a heavy traf-
fic ; another may consider it expedient to obtain as
much as possible from the business offered. But
there is no standard to which a rate must conform
except that it must be reasonable.

As we have seen, a railroad company, regarded
either as a quasi-puhVic corporation or a common
_ carrier, is under public obligations. It

Rates must ^ . ^ .o

be reason- cannot fix its ratcs solely with a view to
its own interests and without regard to
the rights of the public. Stockholders are not the
only persons to be considered. The public cannot
be subjected to unjust charges that dividends may
be earned. But, while a railroad cannot ignore the
rights of the public and exact charges excessively
high, it is equally true that the public have no right
to insist that charges shall be excessively low. The
railroad is entitled to just compensation for services
rendered. Its stockholders cannot be deprived of
a fair return upon their investment. Under the
common law and independent of statute rates must
be reasonable.

The provision in the first section of the Inter-
state Commerce Act that " all charges made for any
service rendered or to be rendered in the trans-
portation of passengers or property . . . shall be
reasonable and just," is merely declaratory of the


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Online LibraryWalter Chadwick NoyesAmerican railroad rates → online text (page 2 of 17)