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Capitol Comment

    Capitol Comment 214 - Railroad Competitive Access: Re-Regulation in Cheap Clothing

    11/19/1998

    By most measures, railroad deregulation under the Staggers Act of 1980 has been a resounding success. The Staggers Act lowered real rail rates on most commodities by 15 percent to 25 percent, saved shippers $11 billion to 18 billion annually due to lower rates and more timely service, and staved off a massive taxpayer bailout of an industry that was a financial basket case.1

    Nevertheless, a number of shipper interests have sought to lower their rates even further by pushing for "competitive access." The most popular version of competitive access is in a bill introduced by Sen. Jay Rockefeller (D-W.Va.).

    The proposal is easiest to understand by means of an example. Suppose the Great Octopus Railroad owns the only track connecting a shipper in Podunk with Chicago. This segment of track is often called a "bottleneck." At Chicago, several competing railroads could take the shipper’s freight to New York, including the Great Octopus. The shipper’s ability to transfer its shipment to the other railroads depends on whether the Great Octopus has established "joint rates" with those railroads for shipments to New York. Under the Rockefeller proposal, the shipper could force the Great Octopus to quote a separate rate for the Podunk-Chicago portion of the trip, and the shipper could then choose which railroad would carry its goods from Chicago to New York.

    The idea sounds like a reasonable way to protect shippers from monopoly pricing – until we understand a few more facts about railroad regulation and railroad economics.

    Railroad Regulation

    Current railroad regulation already offers the shipper in Podunk several remedies if it believes it is paying a monopoly rate. First, the shipper can challenge the rate it pays to ship goods from Podunk to New York. It can challenge this rate even if the shipment gets transferred to another railroad in Chicago. To guard against monopoly pricing, the Surface Transportation Board prohibits railroads from charging more than "stand-alone cost": the cost that would be incurred by an efficient competitor operating only the part of their railroad’s system that the complaining shipper or shippers actually use.

    Second, the Surface Transportation Board is also willing to order some form of competitive access when shippers can demonstrate anti-competitive abuse. If the Great Octopus refuses to let the shipper transfer its goods to a more efficient railroad in Chicago, the Surface Transportation Board could order the Great Octopus to quote a separate rate for the first leg of the journey and allow the shipper to select a carrier for the second leg.

    Railroad Economics

    If the Surface Transportation Board can already order competitive access if a shipper proves monopolistic abuse, then why do some shippers want new laws to promote competitive access? The most likely reason is that competitive access can be a backdoor method of lowering rail rates that are not monopolistic.

    To understand this, realize that railroads have heavy fixed costs. Any railroad needs to price its services so that every customer covers its direct costs, plus makes some contribution to the fixed costs. If the railroad is to offer the most widespread service to the most possible customers, it must be able to offer discounts to the shippers it would lose if it tried to make everyone pay an equal share of fixed costs. The shippers located on bottleneck routes then have to pay a higher share of the fixed costs if the railroad is to stay in business. These captive shippers may believe this arrangement is "unfair," but it gives them lower rates than they would receive if the price-sensitive shippers dropped off the system and left the captive shippers with all of the fixed costs. The "stand-alone cost" test prevents the railroad from charging captive shippers monopoly rates.

    But if the law mandates competitive access, shippers can easily game the system by demanding that each haul be broken into separate pieces, then challenging the reasonableness of rates on the bottleneck pieces separately. Because the stand-alone cost of part of a haul must be less than the stand-alone cost of the entire haul, the rate the railroad can charge on the bottleneck will make a smaller contribution to fixed costs than the previous rate charged on the entire haul. The railroad, meanwhile, cannot make up the lost revenue by charging more on the rest of the haul, because it faces competition on the rest of the haul. In this way, a shipper can use competitive access as a lever to lower its rail rates, even if it is paying less than stand-alone cost for its shipments.

    An Improper Analogy

    A principle rhetorical argument for competitive access is that it will stimulate competition among railroads in the same way that open access for natural gas pipelines, telephone wires, and electric wires stimulates competition among firms in those industries. But rather than making railroad regulation look more like regulation in other industries, regulation in other industries should gradually come to look more like railroad regulation. Competitors building their own facilities have begun to challenge local phone monopolies, and during the past decade, federal regulators have encouraged interstate gas pipeline construction that places pipelines in competition with each other. Over time, even electric transmission wires may face competition from small-scale, gas-fired power plants that can be built near the customer. Thus, the wave of the future should be regulation targeted at pockets of perceived problems, rather than broad-brush approaches covering entire segments of an industry. In this sense, current railroad regulation is ahead of the curve.

    1See Jerry Ellig, "Railroad Regulation and Consumer Interests," CSE Foundation Issue Analysis No. 74 (August 24, 1998)