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the consequences of all direct competition.

A railroad, as we have seen, is in some places a
complete monopoly, in some places a partial mo-
nopoly, and in others not a monopoly at

Effect of

direct com- all. Conversely, unrestricted competition
pe I ion. gj^jg|.g jjj- some stations, limited competi-
tion at some, and no, competition at others. Unre-
stricted competition forces down rates. Charges
upon competitive traffic are likely to be unremun-
erative. When they are so low as to pay only the
proportionate share of operating expenses, non-
competitive traffic must bear the whole burden of
interest charges and dividends, if any are paid.
The first effect of railroad competition, then, is to
make rates unequal — to make non-competitive
traffic pay more than competitive traffic. This pro-
duces low through rates but high local charges.

Let us now see whether direct competition acts as
a regulator of rates. The theory that competition
has this effect is based upon two assumptions: (i)
that the prices of goods are proportional to the cost
of production ; (2) that when the prices of goods
fall below the cost of producing them production
will decrease. These assumptions are well founded
with respect to ordinary forms of industry. When
the supply of goods is limited and prices are far
above the cost of production, outside capital will be
attracted, production will increase until the demand



COMPETITION, COMBINATION 129

is supplied, and then prices will fall to a normal
figure. When prices have fallen below the cost of
production, capital will be withdrawn, production
will be limited, and prices will rise to the normal
standard again. This theory works out, partially at
least, in the case of indirect competition for markets.
When the railroad rate on wheat to Chicago is so
high that the competitive price will not leave a
profit over the cost of production ^///j the transpor-
tation charge, no wheat will be shipped and little
raised — assuming that Chicago is the only available
market. When the rate is reduced and a profit is
in sight, shipments will be made and wheat grow-
ing will increase. Competition for markets tends to
regulate charges, because the amount of the rate may
wholly determine whether the road will have any
competing products to haul.

But the theory that competition regulates charges
does not hold good with respect to direct railroad
competition. The two assumptions upon which it
is based cannot be made, (i) Charges for railroad
services — as we have seen — are not and cannot be
in proportion to the cost of rendering them. The
expenses of a railroad are largely independent of
the volume of trafiic. Business may be competed
for up to the limit of out-of-pocket expense. Rates
which would bankrupt the road if applied to its
whole traffic may be taken with profit if otherwise
the shipments would go elsewhere. (2) When
rates for railroad services fall there is no such thing

9



I30 AMERICAN RAILROAD RATES

as a withdrawal of capital. As we saw in examining
underlying principles, a railroad represents a perma-
nent investment. It is good for a railroad and
nothing else. Competition may force down rates
and the road go into bankruptcy, but it does not
cease operations. Its ownership may change hands
through foreclosure, but the struggle for business
goes on. The deeper a railroad is involved the
more wildly will it endeavor to obtain traffic and
the lower will it cut rates. Anything over the mere
cost of haulage is better than nothing at all. Unre-
stricted competition among railroads instead of act-
ing as a regulator of rates often produces rate wars,
discriminations, and insolvency.

There is another economic theory — that compe-
tition tends to equalize prices. But this does not
work in harmony with the law of increasing returns
which, as we have seen, applies to railroads and
influences railroad competition. The more traffic a
railroad moves the cheaper it can move it, and the
greater the inducement to obtain it. Up to the
point where additional traffic requires additional
facilities, an increase of business shows profits at an
increased ratio. Two million units of traffic will
return more than double the profits of one million
units. Rates may be considerably reduced and
still an increased business be profitable. There is,
therefore, every inducement to the railroad officials,
both of the solvent and insolvent road, to get extra
tonnage. There is an especial triumph in getting



COMPETITION, COMBINATION 131

it away from another road. Competition to obtain
it does not make rates equal. It rather makes
for rate cutting, rebates, and other forms of
discrimination.

In competition in general, the strongest com-
petitor controls the situation. In railroad competi-
tion, the weakest road is often the controlling power.
The bankrupt road which has repudiated its interest
obligations has nothing to lose by reducing its rates
to any figures above the actual out-of-pocket ex-
pense. It must have business upon some terms.
The prosperous road must meet the rate of its
competitor or lose its traffic. Unless it can make
up the loss from its non-competitive traffic, it is not
unlikely, by meeting the rates of its rival, to be
driven into the same financial condition as its rival.
Similarly, the most circuitous and indirect road is
often able to dictate conditions to the most direct
line. The indirect route — possibly a water and
land route — can carry the freight if it can obtain
it. It would not naturally obtain it all, and all it
does obtain is clear gain. In order to obtain traffic
it must offer inducements to shippers. It may
reduce rates almost to the cost of haulage and still
be a little to the good.

Whenever competition compels a railroad to ac-
cept unremunerative rates the loss must fall some-
where. If charges at non-competitive points remain
unchanged it falls upon the railroad. If the reduc-
tion of rates go far enough and continue long enough



132 AMERICAN RAILROAD RATES

bankruptcy will result. On the other hand, if local
rates are raised when they are cut at competitive
_ , . centres the loss falls — and most unjustly

Combina- .

tion the falls — upon the local shipper. As a rule,

alternative . . , , i -i i 11

of competi- rate wars mjure both the railroad and the
*^°"" non-competitive traffic. The competitive

principle in railroading injures the railroad, and works
unfairly to the public because it cannot work equally.

The results of competition being injurious the
only course for the railroads is to stop competing.
But they cannot stop unless they agree to stop.
Combination is the alternative of competition.

Here, however, we are met with the objection
that agreements of railroads in restraint of competi-
tion were illegal at common law. The common law
rule undoubtedly was, " that every combination of
guasi-puhlic corporations which, without statutory
authority, does or may deprive the public of the
benefits accruing from separate control and manage-
ment, is against public policy." ^ But while agree-
ments to maintain rates may be illegal in the sense
that they are not enforceable, they were not — until
the enactment of recent statutes — unlawful in the
sense that they were punishable. The courts took
the parties to such agreements as they found them,
and as they found them left them, without assistance
in any matter growing out of the illegal enterprise.
But the courts could not go further and inflict a
penalty. The railroads were at liberty to enter into

^ Laiv of Intercorporate Relations, sec. 359.



COMPETITION, COMBINATION 133

rate agreements, but they could not enforce them
and could withdraw from them at any time.

Still, although agreements to maintain rates were
not enforceable, the effects of competition were such
that the railroads — before the prohibitory statutes
were passed — freely entered into them. But before
examining their different forms let us consider
another type of agreement growing out of railroad
competition and often constituting the consideration
for the rate agreement — the differential agreement.

A differential may be described as a difference in
rates established by agreement of competing carriers
upon (i) traffic between the same points, Differ-
or (2) traffic from a common point to ^"^^^ ^•
different points, but having the *ame ultimate
destination.

We have seen that the indirect and circuitous
route is often able to dictate terms to the direct
line. It would not obtain any traffic at all without
effort. Concessions to shippers would be necessary
to draw business. Rate cutting would result, and
the indirect line to which the traffic was really extra
tonnage could stand reductions better than the trunk
line whose heavy business would be affected. To
avoid these results differentials were often granted to
the indirect roads — in consideration of agreements
to maintain rates — allowing them to charge lower
rates than others to the same points of destination.
They were thus enabled to attract a share of the traf-
fic. There were two classes of roads — " standard



134 AMERICAN RAILROAD RATES

lines " and " differential lines." Differentials of this
character were, however, practically abandoned about
ten years ago except for freight routed via ocean
and rail and Canadian lines.

The second form of differential has a different
origin. Several railroads may be engaged in haul-
ing grain or flour from an interior centre to differ-
ent seaboard cities for export to foreign countries.
When the ocean rate to one port is higher than to
another the rail rate to that port must be reduced
or the railroad serving it will obtain no traffic.
Ocean rate plus rail rate must be the same upon
each route if there is to be a division of the traffic.
One port may offer better facilities for loading and
unloading and other advantages. Disadvantages
must be compensated for by reduced rates. It fol-
lows, therefore, that the railroad running to the
city having the greatest ocean rate and the least
advantages will be driven by competition to cut
rates the deepest to obtain business. This will re-
sult in a rate war or an agreement permitting the
least favored road to charge a rate sufficiently re-
duced to attract what is considered to be a fair
share of the traffic — in other words, a differential.
Thus export traffic from Chicago may be moved
via Boston, New York, Philadelphia, or Baltimore.
Prior to 1876 the railroads running to those cities
were in active competition for this traffic, and
disastrous rate wars resulted. At that time an
arrangement was entered into whereby taking the



COMPETITION, COMBINATION 135

Chicago-New York rate as a standard, the rate to
Boston was the same ; the rate to Philadelphia, two
cents per hundred pounds less, and the rate to Balti-
more, three cents less. In other words Boston has
a concession over New York of the longer haulage
at the same rate, and the differentials in favor of
Philadelphia and Baltimore are two and three
cents respectively. These differentials have recently
been modified in some respects by the Interstate
Commerce Commission acting as arbitrator. On
the whole, however, the Commission held that
they were fairly adjusted to meet competitive
conditions.

Local differentials are not local discriminations, as
we have used the latter phrase. Specifically, a local
discrimination is an unequal adjustment of rates
upon a single road. A differential is the result of
an unequal adjustment of rates with respect to com-
peting points on different roads. In a broad sense,
however, a locality from which traffic is diverted by
artificially high rates is discriminated against, and
unjustly so when rates are made higher and the
differential greater than is warranted by conditions
of competition.

And now we will return to the rate agreements
which the differential has often induced the railroad
to enter into.

The earliest attempt of the railroads to avoid the
effects of competition took the form of simple
agreements to maintain rates. Prior to the early



136 AMERICAN RAILROAD RATES

seventies these agreements were common and were

entered into openly. They were in slightly different

forms — some containing a provision for

Agreements _ .

to maintain an umpire to settle disputes — and usually

were executed by the general freight agents

of the competing roads. Agreements with respect

to passenger traffic preceded those relating to freight.

These agreements worked well so long as they
were lived up to. Rates were maintained and ruinous
competition avoided. They failed — like the simi-
lar agreements of competing manufacturers — because
there was too much incentive to break them and_
there was no authority to enforce them. They
were based wholly upon confidence. Whether
they were observed depended largely upon sub-
ordinate officials whose confidence in a rival road
was readily impaired. When they believed that
other roads were making concessions to obtain
traffic, they made concessions themselves. An
agreement which each party fails to quite live up to
is often worse than no agreement. Its effect is to
substitute secret competition for that which is open,
and the former is worse than the latter.

If agreements to maintain rates could be made
lawful and enforceable, many of the difficulties
attending them would be obviated. In fact, under
present conditions — which may render a more effec-
tive method inexpedient — enforceable rate agree-
ments may be the best means of dealing with
railroad competition. The difficulty, however, with



COMPETITION, COMBINATION 137

all rate agreements, whether enforceable or unenforce-
able, is that they do not remove the incentive to
competition. The railroad officials soon recognized
this in the case of the early rate agreements. They
saw that the way to avoid the effect of competition
was to remove the inducement to compete. With
this object they resorted to pooling.

A railroad pool is an agreement between compet-
ing railroads to apportion competing business.
More precisely, it is an arrangement made
by several railroads competing for busi-
ness to allot to each a stated percentage of the whole
competitive traffic, or of the receipts thereof, together
with a mutual guaranty that each road shall receive
its share. The purpose of pooling is to remove the
incentive to competition. A road will hardly cut
its rates to get away another's traffic if there is noth-
ing to be gained by doing so.

Railroad pools are of two kinds :

(i) Traffic pools.

(2) Money pools.

I. A traffic or tonnage pool is an agreement
whereby each member is guaranteed to receive and
can receive only a stated percentage of the competi-
tive traffic. Taking a series of years, the percentages
of freight carried by competing and well established
lines between two important points will not vary
greatly. The distribution of business is fairly con-
stant. It is, therefore, easy for the makers of the
pool to determine the proportion of the traffic



138 AMERICAN RAILROAD RATES

which each member should receive. A pool to be
permanent should be based upon natural percent-
ages. A traffic pool only applies to competitive
traffic and sometimes only to through competitive
traffic. Local business is unaffected. In fact, rate
wars with regard to local competitive traffic have
taken place between members of a through traffic
pool. When the time for adjusting accounts ap-
proaches, if any member have received less than its
allotment of the traffic, sufficient freight is diverted
from a road which has received in excess of its per-
centage to make up the deficiency. Freight diverted
for this purpose is, if possible, freight not specially
routed. But sometimes it is necessary to forward
contrary to the preferences of shippers. This makes
trouble, and was so great an objection to the traf-
fic pool that it was largely abandoned, even before
the enactment of the statute against pooling.

At one time an attempt was made to obviate this
objection. Arrangements were made with large
shippers to act as " eveners." These shippers by
forwarding their freight by one road or another as
was required evened up the traffic of each road to its
allotted percentage. The " eveners " were recom-
pensed by receiving rebates on their own ship-
ments and sometimes on shipments made by others.
The " evener " plan began in the live stock traffic.
It is said also that the Standard Oil Company was
a great "evener." These concessions to the very
largest shippers constituted most unjust discrimina-



COMPETITION, COMBINATION 139

tions in favor of those who needed them least.
The evener plan was abandoned about 1879.

II. A money pool is an agreement whereby each
member is guaranteed to receive and can receive only
a stated percentage of the receipts from competitive
traffic. This type of pool — called a joint purse —
has been common in England. It may be based
either upon gross or net earnings. The percentages
of the members are, of course, determined by past
earnings, but they take their allotments entirely ir-
respective of actual earnings during the pool's exist-
ence. But as one road might incur extra expenses
in moving a far greater bulk of traffic than its pro-
portion of the earnings called for, it was customary,
during the pooling period of the American railroads,
for each road to retain a third or a half of the receipts
from the pooled business to cover the actual expenses
connected therewith. The remainder of the receipts
went into the pool. In some cases the roads were
permitted to retain but a very small percentage
in order to avoid the temptation to compete for that
alone. A moiety of the earnings might have been
attractive to a road in need of funds.

The money paid into a money pool is periodically
distributed by the official in charge according to the
stipulated allotments. In this type of pool each
road takes all the business offered and conducts its
affairs independently of the other members, except
as it pools its receipts in whole or part.

The advantage of the money pool over the traffic



I40 AMERICAN RAILROAD RATES

pool is that it obviates the necessity for diverting
traffic from the route designated by shippers or for
employing " eveners." If shippers are receiving fav-
ors from a particular road they are especially likely
to object to any diversion of their shipments. The
difficulty with the money pool lies in the reluctance
of a railroad to pay over to a competitor any part of
the money which it has earned. It is much easier
to receive to make up one's own deficiency than to
give to supply the shortage of others. This diffi-
culty was, however, largely avoided by providing
that members should pay their receipts into the
pool in advance, instead of waiting until the expira-
tion of the stated period to see how the different
members stood.

An objection to the money pool as it existed in
this country, from a public point of view, was that
it was sometimes used, not as a means of pooling
business, but as a method of hiring weak roads not
to compete. There was another objection to both
types of pools from the railroad standpoint. They
did not wholly eliminate the inducement to com-
pete. As they usually ran for a comparatively
short time, there was always an incentive to obtain
additional tonnage in order to make a good showing
for future allotments. On the other hand, this spur
to look out for the future was beneficial from the
public point of view. One of the serious difficulties
with pooling was that after joining a pool a railroad
had little inducement to improve its facilities — that



COMPETITION, COMBINATION 141

it tended to stagnation. But with short term pools
each road had to keep up its service to hold its ex-
isting percentage when the new allotment should be
made. It could legitimately improve its position
to claim a larger share only by offering increased
advantages and attracting new business.

III. The primary objection of the public to pools
was that they were (i) designed to increase charges,
and (2) had that effect. The purpose of a pool,
however, is to maintain rates, not to establish them.
Rates may be fixed by wholly outside causes, such
as water competition. A pooling arrangement may
continue for a term during which hundreds of
changes in the tariff may be required. While the
effect of a pool is to make rates uniform as well as
stable, rate-making is distinct from pooling. The
pools were not designed to increase rates and they
did not have that effect. In the seventies and early
eighties, when pools were most prevalent in this
country, rates steadily declined.

Neither did the pools materially check the decline
in rates. Of course, in so far as direct competition
tended to accelerate the decline, pooling, by eliminat-
ing that competition, tended to stay it. But as we
shall see, direct competition was not an important
factor in causing the general decline in charges.^ It
acted only upon competitive rates and tended rather
to keep local charges up than down. Rates steadily
declined under the pooling arrangements, and it

1 See Chap. VII.



142 AMERICAN RAILROAD RATES

cannot safely be asserted that they would have
declined much faster if the pools had not existed.
In fact, the pools by preventing ruinous competi-
tion enabled the railroads the better to avail them-
selves of those physical improvements which were
the most important factors in bringing about the
decline in charges.

IV. The first important railroad pool in this
country was the Chicago-Omaha pool which was
formed in 1870. The Northwestern, the Rock
Island, and the Burlington roads which connected
Chicago and Omaha, were not far different in finan-
cial means and had about equal facilities for hand-
ling the business. The trafiic between the two
points was important. It was obvious that no one
road was in a position to get the others' business
away by cutting rates — that all were equally capable
of standing competition. All the conditions pointed
to an equal division of the traffic — to co-operation
instead of competition. Accordingly, a pooling
agreement was made allotting to each road a third
of the traffic. This pool was successfully maintained
all through the Granger agitation and was merged
into the Western Freight Association in 1884.

Another early Western pool was the Southwestern
Railway Rate Association, established in 1876. This
pool related to traffic between Chicago and St. Louis
and Mississippi River points. It was somewhat
similar to the Chicago-Omaha pool, although there
were more parties to it and it endeavored to fulfil



COMPETITION, COMBINATION 143

other functions than those of a mere pool. It existed
for a few years and was only partially successful.

An early Eastern pool was that formed by the
railroads engaged in producing and carrying anthra-
cite coal to the Atlantic seaboard, which was organ-
ized in 1872 and continued in its original form
about four years. This pooling agreement re-
stricted the amount of coal to be mined, and appor-
tioned the production and traffic in stated percentages
among the roads participating. It was followed by
others of a similar nature which were more or less
effective.

Probably the most effective and comprehensive
pool established in this country was that organized
in the Southern States in 1875, called the Southern
Railway and Steamship Association. This pool
first covered the business between Southern points
and the Eastern cities, but later took in Western
traffic. Its members were both railroads and steam-
ship lines. It was a money pool, the roads partici-
pating paying eighty per cent of their earnings from
the competitive traffic into the pool for distribution.
This association was much more than a mere pool-
ing agreement. It fixed rates, made classifications,
and established a clearing-house for the settlement
of joint-traffic accounts. It was directly controlled
by a general commissioner with large powers acting
under the supervision of an executive committee.
It was well managed from the start, and continued
In successful operation until the abolition of pool-



144 AMERICAN RAILROAD RATES

ing in 1887, when its functions were necessarily-
changed.

Trunk line pools followed the development of
trunk line traffic.^ Before steel rails came into use
with the resulting larger cars and heavier engines,
the great bulk of traffic between the West and the


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Online LibraryWalter Chadwick NoyesAmerican railroad rates → online text (page 9 of 17)