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Capitol Comment 215 – Do Rail Mergers Mean Higher Rates?

The railroad industry has undergone a large number of mergers since 1981, which has raised fears of monopolization. Some economists and most politicians equate the number of competitors or degree of industry concentration with the robustness of competition. They reason that, as mergers leave more shippers served by only one railroad, surely higher rail rates must follow.

A quick comparison of rail mergers and rail rates, however, shows just the opposite relationship. Between 1981 and 1996, the number of Class I freight railroads in the United States fell from 35 to nine.1 Nevertheless, the graph shows that as the number of major railroads in the United States shrunk, rail rates steadily declined! This does not necessarily prove that mergers always cause lower rail rates, and much more sophisticated analysis must be employed to ascertain mergers’ actual effects. But the graph does undermine the simplistic claim that mergers and consolidation must bring higher rates.

The claim is based on the idea that fewer competitors mean less competition, and less competition means higher prices and monopoly profits. A significant body of research casts doubt on this generalization.2 Even if it were true, however, two factors must be kept in mind when discussing rail mergers.

First, it is highly misleading simply to use the number of major railroads in the country as a measure of competition. Individual railroads do not cover the entire country; their operations are concentrated in different regions. A merger of railroads that do not compete with each other in the first place cannot reduce competition. Most of the rail mergers since 1980 have been “end-to-end” mergers of adjoining railroads, not mergers of roads that competed to serve the same locations.3

Second, mergers can also reduce railroad costs, which helps lower rates. No analysis of mergers is complete that ignores the effects of lower costs on rates. In the railroad industry, there is evidence that mergers do indeed lower costs. A 1993 study found that mergers that took place following passage of legislation to deregulate the rail industry were responsible for about 10 percent of the cost savings railroads achieved since 1980.4

Why do mergers lower costs? Economic studies suggest that mere size does little to affect a railroad’s unit costs; bigger is not per se better. However, increasing the length of haul and increasing the density of traffic can reduce costs significantly. A longer haul on a single railroad saves the costs that two railroads formerly bore when they sorted and exchanged cars with each other. Increased density of traffic means that there are more shipments to share the costs of a particular stretch of track. Therefore, a merger of adjoining railroads that turns two shorter hauls on separate railroads into one longer haul on a single railroad has the potential to cut costs. Similarly, a merger of two competing railroads that results in the abandonment of some mainline track and fuller utilization of the remaining track can also lower costs. Steadily declining rail rates suggest that railroads have found it profitable to pass much of the cost savings on to shippers in order to attract or retain business. For these reasons, railing against mergers will do little to lower rates.

1Not all of this drop was due to mergers; six railroads that were considered Class I in 1981 no longer qualify under current Surface Transportation Board criteria, one went out of business, and one became a commuter passenger carrier.

2Yale Brozen, Concentration, Mergers, and Public Policy (New York: MacMillan, 1982); Brozen, “Bain’s Concentration and Rates of Return Revisited,” Journal of Law & Economics (Oct. 1971), pp. 351-70; Harold Demsetz, “Industry Structure, Market Rivalry, and Public Policy,” Journal of Law & Economics 16 (1973), pp. 1-9; Sam Peltzman, “The Gains and Losses from Industrial Concentration,” Journal of Law & Economics 20:2 (Oct. 1977), pp. 229-63; Robert Bork, The Antitrust Paradox (New York: Basic Books, 1978); Dominick Armentano, Antitrust and Monopoly: Anatomy of a Policy Failure (New York: John Wiley & Sons, 1982).

3Christopher A. Vellturo, Ernst R. Berndt, Ann F. Friedlaender, Judy Shaw-Er Wang Chang, and Mark H. Showalter, “Deregulation, Mergers, and Cost Savings in Class I US Railroads, 1974-1986,” Journal of Economics and Management Strategy 1:2 (Summer 1992), p. 342.

4Ernst R. Berndt, Ann F. Friedlaender, Judy Shaw-Er Wang Chiang, and Christopher A. Vellturo, “Cost Effects of Mergers and Deregulation in the US Rail Industry,” Journal of Productivity Analysis 4 (1993), pp. 127-44.