Railroading The Railroads

In recent years, members of Congress have worked with various interest groups for the purpose of imposing new economic regulations on the freight rail industry. This action has been partly led by concerns over the scale of consolidation that has occurred in recent years.

The consolidation of this industry is the end result of gains in efficiency and productivity that have come about from railroads having greater freedom to adjust their behavior to cater to the needs of their shippers. Prior to deregulation, a regulatory board called the Interstate Commerce Commission (ICC) had veto authority over most major decisions of freight carriers. The ICC forced firms to maintain service in unprofitable regions, imposed rate ceilings, and bizarrely also required railroads to keep their shipping rates artificially high    Needless to say, railroads under this regulatory regime lacked the revenue or the incentives necessary to maintain healthy railway networks.

With the freedom that came with deregulation, carriers cut waste by discontinuing unprofitable lines and poured cash—more than $500 billion since the enactment of 1980’s Staggers Rail Act—into upgrading and expanding infrastructure in order to cater to the greatest number of shippers at the highest level of quality. According to the Association of American Railroads, as of June 2012, inflation-adjusted rates charged to shippers have dropped by 45 percent since the Staggers Act. Larger carriers that could exploit their economies of scale were able to use their size to charge the lowest rates.

Many are now calling for new regulations to mitigate the perceived harm that post-deregulation railroad consolidation has imposed on shippers. Unlike most sectors, railroads currently retain limited exemptions from antitrust law. Some shippers only have access to only a single carrier with which to transport their products. Critics of the status-quo are now accusing large railroads of abusing their market power to charge excessively higher rates to shippers that do not have any viable alternative to doing business with them. Their proof is in the slight increase in shipping rates that has come about since 2004. In addition, the three large Class I publicly traded carriers (BNSF is wholly owned by Warren Buffett’s Berkshire Hathaway) recently reported profit margins exceeding 15 percent.

These critiques are deeply flawed. The small rise in shipping rates since 2004 can be largely explained by generic costs increases, primarily the rising price of diesel fuel needed to power locomotives. This has been confirmed by research commissioned by the Surface Transportation Board. The rise in freight rail profits should not be viewed as a sign of price gouging either. Like other capital-intensive sectors, railroads require large investments in the building of network of tracks years before any shipments begin. Most railroads profits go towards recouping costs and debts incurred from past network investments.

The changes these shipper interest groups are proposing would seriously undermine the business model that has allowed the railroads to better serve their customers. One proposal is to force a carrier that is the sole shipper for an area to allow “open access” of their tracks to competing railroads to use in order to offer greater choices for producers that are “captive” to a single railroad. If given the choice between building new track to reach new customers or simply free-riding off of a competitor’s track, railroads would opt every time to avoid paying the high costs of building new facilities. Such a rule would severely reduce the incentive to invest in network enhancements, which would lead to lower quality infrastructure, increasing rail congestion, and ultimately higher rates.

Ultimately, it is in the public interest for producers that have access to only a single track to move their goods pay higher rates than areas with more carrier choices. Given that railroads have large fixed costs, they derive greater returns from higher utilization of their capacity because it allows them to recoup these fixed costs faster. But if a geographic area has a lower concentration of production and only one railroad has opted to invest to serve the small number of potential customers, shippers might end up paying higher rates in order to mitigate the capital and operating risks of such low-demand segments. For it to be profitable for a railroad to build tracks in areas with lower demand and continue to maintain the segment in the future, it is imperative that freight companies be given the flexibility to charge rates that allow them to effectively provide their service.

The takeaway is that if these dangerous policies are enacted they would be applied wholesale to the entire freight rail industry. According to recent analysis, the forced access proposal would affect 26 percent of total U.S. rail traffic. Despite the consolidation of the rail industry, competition between market players for market share remains robust. The fact that interest groups are proposing regulations that impose broad changes on all railroads despite there being no evidence of market power abuses on the part of the railroads shows that these groups are merely seeking anti-market political favors.

For more on railroad regulation, see CEI Fellow Marc Scribner’s recent study, “Slow Train Coming? Misguided Economic Regulation of the Railroads, Then and Now.”