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.

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.

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.

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.

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.

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

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

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

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

The Standard of Freight Charges under a Regime of Monopoly. - 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.

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.”