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The Sad, Early History Of Railroad Regulation: From Subsidies To Nationalization

CEI has long made it its mission to highlight to downsides and dangers of economic regulation. One classic example is the experience with America's railroads following the Civil War. Most of the transcontinentals were heavily subsidized by all levels of government via sub-market-rate loans, land grants, and special local privileges on the frontier. What arose in response was the first coordinated federal interstate regulatory regime, a deeply misguided endeavor that ultimately took more than a half-century to only partially reverse and with severe consequences that we are still living with today. What follows is excerpted from a forthcoming study on railroad regulation.

Following the creation and heavy subsidization of the first transcontinental railroads in the 1860s, populist opposition over alleged predatory practices in the railroad industry began to grow. By the 1870s, the National Grange of the Order of Patrons of Husbandry (the Grange), American farmers’ chief special interest group, gained significant power in a number of Midwestern states. But the Grangers’ call for railroad regulation was most powerfully trumpeted by wealthy Midwestern merchants and wholesalers, not the typical family farmer.

The rent-seeking Grange and other rural Western political activists, portraying themselves as victims, managed to convince Congress in 1887 to create the Interstate Commerce Commission (ICC) to regulate common carriers, the first national industrial regulatory body in the United States. Congress declared that all freight and passenger rates “shall be reasonable and just,” and outlawed those rates that were not, as determined by the ICC. The law also restricted price discrimination over long- and short-distance trips, as well as pooling contracts between railroads. Subsequent United States Supreme Court decisions greatly weakened the ICC’s enforcement powers.

The populist Grange soon allied with a technocratic Progressive movement beginning near the end of the 19th century. In 1903, Congress passed the Elkins Act. The law forbade railroads from offering rebates to large corporations and required that railroads publish their rates. However, the Elkins Act did not authorize the ICC to determine whether the published rates were “reasonable,” and therefore did little to calm the pro-regulation cries from the Grangers and Progressives.

In 1906, Congress passed and President Theodore Roosevelt enthusiastically signed the Hepburn Act into law, which overruled the Supreme Court, strengthened Elkins provisions and authorized the ICC to set maximum freight and passenger rates. These price controls greatly devalued railroad stock, leading to the Panic of 1907, which was later used to justify the creation of the Federal Reserve System in 1913. In 1910, President Taft signed the Mann-Elkins Act, which strengthened the Hepburn Act’s maximum rate-setting provisions and the original Interstate Commerce Act’s provisions on short- and long-haul price discrimination.

Those concerned with regulatory overreach did not completely fail in reversing some of the Hepburn Act’s expansions of ICC authority. One provision of Mann-Elkins that sought to restrain the ICC’s power was the creation of the Commerce Court. The Court was tasked with reviewing ICC rulings and overturning those that were found to be unreasonable. By late 1911, the Commerce Court had reversed the majority of ICC rulings that had come before it, making it highly unpopular among anti-railroad interests, such as the Progressive Party, which advocated the Court’s abolition in its party platform. Following a bribery scandal that involved a Court judge, Congress passed the Urgent Deficiencies Act in 1913 that abolished the Commerce Court and placed ICC review jurisdiction with federal district courts.

This reorganization reduced the expertise in scrutinizing ICC rulings and had the effect of strengthening the ICC’s power over the railroad industry. This could not have happened at a worse time. The following year, the First World War broke out in Europe and American companies started supplying the war’s belligerents. Yet with Germany’s unrestricted submarine warfare on merchant ships in the Atlantic, ship capacity on the East Coast of the United States became greatly constrained. These factors resulted in a great increase in railroad freight traffic, leading to serious congestion problems in many corridors, particularly on export traffic bound for East Coast ports.

The railroad industry, shippers, and government officials recognized that congestion problems needed to be resolved. Unfortunately, several laws and regulatory decisions had greatly restricted the ability of railroads to respond to market conditions and add capacity where it was most needed. Pooling equipment and facilities could have eased the traffic crunch in the short-run, but the Interstate Commerce Act explicitly prohibited the voluntary pooling of railroad resources. In 1917, railroads appealed to the ICC for a 15-percent rate increase to help offset some of the rising costs associated with wartime traffic and afford them the opportunity raise revenue necessary to invest back into network enhancements. The ICC rejected their request.

Frustrated with the growing railroad network inefficiencies during the war, President Wilson nationalized the entire railroad industry. On December 28, 1917, the newly formed United States Railroad Administration took over American railway operations. The agency immediately pooled all railroad equipment and facilities, and six months later increased freight rates by 28 percent. Federal control of America’s railways continued through the rest of the war until the Esch-Cummins Act, commonly known as the Transportation Act of 1920, was enacted in February 1920.

The railroads may have been de-nationalized following World War I, but languished for several decades more in a regulatory morass. Only when the entire industry was on the brink of collapse in the 1970s did Congress see fit to begin moving in a deregulatory direction.