Will New Regulation Derail the Railroads?

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Despite the success of railroad deregulation, some shippers and shipper groups have called in recent years for new regulation of the railroad industry. Two principal types of regulatory proposals are before Congress: “open access” and “bottleneck rate” legislation. These attempts to expand railroad regulation threaten a return to the discredited era before deregulation when wide-ranging regulatory controls deterred investment and caused much of the rail industry to collapse.

Those groups who call for new regulation seem to want better service but to pay lower prices. This outcome will not occur. Service improvements require significant investment in track, freight cars, locomotives, information technology, and other assets. The new proposed regulations would reduce incentives for investment in railroad assets, cause railroads to lose business to competing modes of transportation, and threaten the already weak financial health of the railroads. If Congress discourages railroads from investing in track capacity, or other assets, service will deteriorate rather than improve, and the private railroad industry will not survive.

Pending open access and bottleneck rate legislation would discourage future investment in the following ways:

• Open access and bottleneck rate regulation would drive down railroad revenues towards variable costs. But this outcome fails to cover the very large fixed and common costs incurred by railroads, such as laying track or digging tunnels. No railroad will make these investments unless it can expect to recover its investment.

• Open access will discourage railroads from making investments in their own networks if they are forced to permit competing railroads to free-ride on those investments. Similarly, the proposed legislation would discourage railroads from expanding into new markets so long as they can obtain forced access to a competitor’s tracks.

• Cost-based price caps will not permit the railroads to achieve a market return on investments. Both open access and bottleneck rate regulations will require the federal government to impose caps on access fees and bottleneck rates. Assuming the use of the current cost-based approach, the government will cap the prices too low because the cost-based approach ignores the asymmetric return on railroad investments created by the sunk costs and irreversible nature of those investments.

This paper analyzes the consequences of the proposed new regulations of the railroad industry from the perspective of consumer welfare. I believe consumer welfare — the costs paid and benefits enjoyed by consumers — is the appropriate standard against which to address the current regulatory proposals. It is equivalent to a “public interest” standard.