Whither the Rail Renaissance? The Specter of Reregulation Haunts America’s Railroads Marc Scribner Research Fellow Competitive Enterprise Institute Preserving the American Dream Conference 2013

Overview Brief history of railroad economic regulation and deregulation Current position of the railroad industry Current efforts to reverse partial deregulation Where we ought to go from here

The Birth of Economic Regulation of U.S. Railroads Railroads largely unregulated for first two decades 1844: New Hampshire creates first (advisory) state railroad commission 1860s-1870s: Grangers gain control of state legislatures and add enforcement power to commissions 1885: 24 states plus the Dakota Territory have railroad commissions

Federal Intervention and the Early ICC 1886 – Supreme Court decision in Wabash, St. Louis & Pacific Railway Company v. Illinois greatly limits states’ ability to regulate railroads 1887 – Interstate Commerce Act enacted; Interstate Commerce Commission created – Weak enforcement powers (ICC could not directly enforce, must sue in federal court) – Undercut by SCOTUS, Interstate Commerce Commission v. Cincinnati, New Orleans and Texas Pacific Railway Co. (1897) – ICC cannot make law and therefore cannot set rates

A Defanged ICC & Progressive “Fixes” Progressives and rural populists want an ICC with teeth (Elkins Act (1903) banned rebates but failed to grant direct enforcement) T. Roosevelt becomes president, makes railroad regulation top priority (1901) – Breaks up Hill/Morgan’s Northern Securities (1904) – Signs Hepburn Act into law (1906) – Aggressive ICC enforcement follows

The World at War Wartime traffic snarls rail corridors, railroads appeal for 15% general rate increase, denied (1917) Wilson nationalizes railroads, pools equipment and facilities, increases freight rates by 28% Transportation Act of 1920 returns rail to private sector National Transportation Plan begins umbrella ratemaking (1940) Gasoline and tire rationing, coupled with wartime traffic, boosts fortunes of railroads through WWII Umbrella ratemaking: “the minimum rate for one carrier mode is held higher than it would prefer in order to permit another carrier, with a higher variable cost, to compete” umbrella ratemaking

The Long Decline Postwar railroads face declining modal shares and revenue, increasing costs, regulatory inflexibility Industry, academics, and some gov’t officials first recognize harm done by regulation Important: James C. Nelson, “Effects of Public Regulation on Railroad Performance,” American Economic Review, Vol. 50 No. 2, May 1960.

The Death and Life of Great American Railroads Penn Central files for bankruptcy (1970) Nixon signs Rail Passenger Service Act creating Amtrak (1970) 3R Act (1974), 4R Act (1976) (creating Conrail, ending umbrella ratemaking, deregulating produce movements, legalization of contract rates) Staggers Rail Act (1980) (Title II exempts most movements from rate regulation—180 R/VC rule)

The [Freight] Rail Renaissance Operating nearly 140,000 miles of track Average real rail rates down 44% since 1980 while ton- miles have doubled Over $20 billion in annual private investment since 2007 Today, U.S. has lowest freight rail rates in the world Rail is a critical freight mode 7 Class I RRs ≈500 Class II & III RRs

Attempts to Reregulate Since Staggers Some shippers began seeking ways to reregulate almost immediately following Staggers Issues are largely related to rates and access Mostly regulatory and legal battles So far failed to reverse deregulatory trend ICC abolished in 1995 and replaced by the Surface Transportation Board Class I railroads merge into four majors

Recent Events Shaping Current Regulatory Environment 1998—Ex Parte 575 before the STB: board declines to impose harsh competition policies and defers to Congress 2000—STB imposes Class I merger moratorium and issues revised policy in 2001 making Class I mergers much more difficult 2006-present—Herb Kohl and now Amy Klobuchar (top Dems on Senate Judiciary antitrust panel) introduce Railroad Antitrust Enforcement Act in each session 2007—Railroad Competition and Service Improvement Act introduced by Oberstar and Rockefeller (fails; watered down bill in 2011 also fails)

The Current Proceeding (EP 711) Result of a National Industrial Transportation League (NIT League) petition in Ex Parte 705, competition in the railroad industry (2011) Proposal to revise reciprocal switching regulations so that more movements would be subject to forced switching

Reciprocal Switching? When one rail carrier interchanges rail cars with another rail carrier to access a terminal served by only one of the railroads Can occur voluntarily, although Class I mergers largely made Class I switching unnecessary

Current Rules Governing Forced Access The 180 R/VC threshold (49 U.S.C. § 10707(d)) must be met for the STB to consider questions of market dominance Rates that result in R/VC ≥ 180% do not necessarily provide for forced switching Under 49 U.S.C. § 11102(c), forced switching may occur if one of the following is determined by the STB: 1)a mandate is “practicable and in the public interest”; or 2)“such agreements are necessary to provide competitive rail service”

NIT League’s Proposal Impose forced access if the following four conditions are met: 1.Shipper served only by a single Class I railroad; 2.There is no effective intermodal or intramodal competition for the movements in question; 3.A working interchange exists or could exist within 30 miles of shipper’s facilities; and 4.Mandating switching is feasible and safe, and would not unduly hamper the affected carrier’s ability to serve its shippers

The Devil in the Details Condition 2: There is no effective intermodal or intramodal competition for the movements in question Would impose a “conclusive presumption” of a lack of “effective competition” when: 1.Rates reach or exceed a 240 R/VC; or 2.Any carrier has a market share of 75 percent or more Traditional R/VC “public interest” determinations would no longer apply— automatic forced access

Isn’t 240 R/VC Inherently Excessive? No—rail is a declining-cost industry – High fixed costs – Declining average costs – Marginal costs are less than average costs (so P=MC can’t cover total costs and bankrupts the company) – Most efficient way is to charge highest prices to those with most limited options beyond a given rail carrier (Ramsey pricing)

How Bad Is the Supposed Problem? R/VC ratios between 180% and 300% are common, accounting for approximately 1/7 of total traffic—although the share has been declining Over 80% of traffic ≤ 180 R/VC Segments with highest R/VC ratios are low demand and reflect heightened risk to infrastructure investment The rate dispute process is currently being streamlined

A Cure Worse than the Disease Increased reciprocal switching will lead to increased terminal congestion, the most common cause of network congestion Forced switching will almost certainly lead to service degradation While rates to some shippers will decrease, average rates are unlikely to fall and the network as a whole will be worse off

Continued Investment is Critical to Future Network Health To accommodate expected 2035 demand, railroads will need to finance about $150 billion in improvements Railroad investors have been clear that reregulation will lead them to demand higher dividends at the expense of network investment

Onward! Continue Deregulation The deregulatory process has not been completed Residual rate regulation still creates inefficiencies STB has failed to resolve the longstanding dispute between carriers and shippers Voluntary arrangements between shippers and carriers should be encouraged to resolve “captive shipper” dispute Congress should abolish the STB

Whither the Rail Renaissance? The Specter of Reregulation Haunts America’s Railroads Marc Scribner Research Fellow Competitive Enterprise Institute Preserving the American Dream Conference 2013