Association of American Railroads Page 1 of 1
1 Defined by the Surface Transportation Board as freight railroads having annual operating revenue of
$258.5 million or more in 1999.
STATEMENT OF EDWARD R. HAMBERGER
PRESIDENT AND CHIEF EXECUTIVE OFFICER,
ASSOCIATION OF AMERICAN RAILROADS
BEFORE THE CANADA TRANSPORTATION ACT REVIEW PANEL
OCTOBER 6, 2000
Introduction
The Association of American Railroads appreciates the opportunity to express its
views regarding the statutory review of the Canada Transportation Act currently
underway.
The Association of American Railroads is the primary trade association
representing the interests of North American railroads. Our members, which include
Canadian National, Canadian Pacific and a number of other Canadian railroads, account
for the vast majority of rail mileage, rail employees, and rail revenue in Canada, Mexico
and the United States. U.S. member railroads collectively own and operate hundreds of
miles of rail line in Canada, and Canadian railways own and operate a number of U.S.
railroads, including three major Class I carriers.1
The U.S. rail industry’s interest in the ongoing review of the CTA is deep rooted.
Simply put, whatever affects Canadian railroads also affects railroads elsewhere in North
America. This is so because the North American freight rail system is an operationally
and administratively integrated system of some 190,000 route miles operated by more
than 600 individual rail companies. Together, these firms provide what is by far the most
efficient, cost-effective freight rail system in the world. Importantly, U.S. and Canadian
railroads — in sharp contrast to railroads nearly everywhere else — are almost entirely
privately-owned and provide rail service without appreciable government subsidies.
As you well know, the review of the CTA, like the preparation of the Estey and
Kroeger Reports before it, has provided an opportunity for certain groups in Canada to
call for changes in the existing system of economic regulation of railroads. Some of the
same calls are being heard in the United States..Association of American Railroads Page 2 of 1
Proposals to alter the current system of economic regulation of railroads in both
Canada and the United States include a variety of different approaches, ranging from the
relatively benign (e.g., encouraging the increased use of voluntary arbitration to settle
railroad-shipper disputes) to the truly radical (e.g., mandated forced access on all railroad
rights-of-way under terms set by the government). Few of these proposals represent truly
new thinking; most have been advocated, and rejected, at one time or another in the past.
In the United States, many of these proposals were explicitly rejected by Congress as
recently as 1995 during deliberation on the ICC Termination Act.
The end result of most of these proposals is the same: they would have the
government force railroads to lower their rates to certain favored shippers at the expense
of other shippers, rail employees, rail investors and the public at large. And if the favored
groups had their way, the government would take such action without requiring any
showing of anti-competitive conduct by railroads, without showing that railroads had
actually abused their market power, without showing that railroad profits are excessive,
and without any opportunity for cost coverage or ability to sustain rail investment.
The U.S. rail industry is opposed to such measures, for good reason, and my
comments below will expound on these reasons in more detail. And while there are
certainly some important differences between the U.S. and Canadian railroad industries
and the environments in which they operate, there are strong and significant parallels.
Drawing on the U.S. experience and these parallels, my comments will focus on the
dangers that excessive government economic regulation of railroads presents to rail
customers, to the economy at large, and to railroads themselves.
The Impact of the Staggers Act
To begin, it would be useful to briefly describe the history and consequences of
the economic regulation of U.S. railroads.
In 1887, the U.S. Congress passed the Interstate Commerce Act, creating the
Interstate Commerce Commission (ICC) and making railroads the first U.S. industry
subjected to comprehensive federal economic regulation. For the next 93 years, the
federal government controlled broad areas of railroad operations, ultimately leading to the
near destruction of the industry.
By the 1950s and 1960s, harmful regulation of railroad rates and services, the
rapid growth of truck and barge competition (aided by tens of billions of dollars in federal
funding for construction and maintenance of the interstate highway and inland waterway
systems) and huge losses in passenger operations led to ever greater railroad bankruptcies,
abandonments, service deterioration, deferred maintenance and general financial decline.
By the 1970s, archaic regulations, in combination with strong competition from
other modes and changing shipping patterns, drove the railroad industry literally to the
brink of ruin. During the 1970s, virtually every major railroad in the Northeast United.Association of American Railroads Page 3 of 1
2 U.S. Department of Transportation, A Prospectus for Change in the Freight Railroad Industry (October
1978), p. 25.
States — including the giant Penn Central — as well as several major Midwest railroads
filed for bankruptcy. More than 21 percent of the nation’s rail route mileage was
accounted for by railroads operating under bankruptcy protection. Between 1970 and
1979, the rail industry’s rate of return on net investment never exceeded 2.9 percent,
reached a low of 1.2 percent and averaged a paltry 2.0 percent.
Railroads lacked the capital to properly maintain their tracks. By 1976, more than
47,000 route-miles — about 25 percent of the nation’s total — had to be operated at
reduced speeds because of dangerous conditions. The amount of deferred maintenance
was in the billions of dollars and the term “standing derailment” (in which stationary
railcars simply fell off poorly maintained track) entered the railroad lexicon. By 1978,
the rail share of intercity freight had fallen to 35 percent, down from 75 percent in the
1920s.
The weakness of the U.S. rail industry was no surprise, given the increasingly
strong intermodal competition and the extent and severity of the inequitable railroad
regulation. Maximum and minimum rail rates were set by regulatory fiat, and often were
completely unrelated to costs or demand. Railroads had no conceivable mechanism for
covering the full costs of their system. As the U.S. Department of Transportation noted
in 1978, “The current system of railroad regulation … is a hodgepodge of inconsistent
and often anachronistic regulations that no longer correspond to the economic condition
of the railroads, the nature of intermodal competition, or the often-conflicting needs of
shippers, consumers, and taxpayers.”2
The status quo was clearly untenable, so Congress essentially had two options:
nationalization, at a continuing cost of untold billions of dollars, or deregulation and
reliance on the free market. Congress wisely chose deregulation, and almost exactly 20
years ago this month passed the Staggers Rail Act of 1980. In enacting the Staggers Act,
Congress recognized that railroads faced intense competition from trucks and other
modes for most freight traffic, but prevailing regulation prevented railroads from earning
adequate revenues and competing effectively. Survival of the railroad industry required a
new regulatory scheme that allowed railroads to establish their own routes, tailor their
rates to market conditions, differentiate rates on the basis of demand, and have the
opportunity to earn revenues adequate to sustain their operations.
The basic principle of the Staggers Act was simple: railroads should be permitted
to act much as other businesses in managing their assets and pricing their services. Some
of the Act’s more important provisions were the following:
•Demand and competition were to be the principal regulators of rail rates; rate
regulation was to continue only where effective competition was absent.
•Railroads were allowed to price competing routes and services differently, to.Association of American Railroads Page 4 of 1
3 Carl D. Martland, “Sources of Financial Improvement in the U.S. Rail Industry,” in Proceedings of the
Transportation Research Forum, 39 th Annual Meeting, 1997.
Individual rail rates are not available for study, since approximately 70 percent of all U.S. rail traffic is
transported under confidential terms agreed to by the rail customer and the participating railroad(s).
Revenue per ton-mile (RPTM) is commonly used as a rate surrogate because it measures both the actual
payments made by rail customers and the bases for which the rates are assessed — weight and distance.
However, it is sometimes claimed that revenue per ton-mile (RPTM) is an unreliable indicator of railroad
rates, since it can be affected by changes in commodity mix, length of haul, equipment ownership, and other
shipment characteristics. While RPTM can be affected by such changes, numerous studies that have
controlled for changes in commodity mix and shipment characteristics have confirmed that the decline in
RPTM is not simply a statistical illusion.
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•Railroads and shippers could enter into confidential contracts covering rate and
service provisions.
•Procedures for the abandonment and sale of rail lines were streamlined.
The Staggers Act did not completely deregulate the U.S. rail industry. In addition
to retaining authority over a variety of non-rate areas, the ICC retained the authority to set
maximum rates or take certain other actions if a railroad was found to have abused its
market power or engaged in anti-competitive behavior. Thus, the Staggers Act
established a “safety net” to address the needs of rail customers for whose traffic there is
no effective competition.
It is difficult to overestimate the benefits that have accrued to the U.S. economy,
shippers, and the U.S. rail industry because of the removal of most of the destructive
economic regulations that had debilitated the railroads prior to the Staggers Act.
Consider:
•Lower rail rates brought about by Staggers — down 57 percent in real terms
(measured by revenue per ton-mile) from 1981 to 1999 — have saved shippers
and their customers $10 billion or more per year, according to independent
analyses. These rate declines, which have occurred across commodities and
geographical areas, have been made possible by sharp reductions in railroad costs
that have been passed on to rail customers. As one scholar aptly put it, “The
problem facing the rail industry is that nearly all of its hard-earned cost savings
are given to customers in the form of lower rates.”3
•According to the U.S. Department of Labor, productivity gains in the U.S. railroad
industry since Staggers have exceeded those of nearly every other U.S. industry.
Revenue ton-miles per constant dollar of operating expense is a useful overall
productivity gauge. By this measure, which incorporates all cost components that
contribute to rail operations, overall rail productivity rose 171 percent in the post-Staggers
period, compared to just 10 percent in the comparable pre-Staggers
period. These huge productivity gains made the significant rate decreases.Class I Railroad Performance: 1964-1999
(1981 = 100)
0
50
100
150
200
250
300
1964 1969 1974 1979 1984 1989 1994 1999
Staggers Act passed October 1980
Source: AAR
Productivity
Price
Volume
Revenue
Productivity = revenue ton-miles per constant dollar operating expense
Volume = revenue ton-miles
Revenue = constant dollar operating revenue
Price = constant dollar revenue per ton-mile
Association of American Railroads Page 5 of 1
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•After decades of steady decline, the U.S. rail market share (measured in ton-miles)
bottomed out at 35 percent at the end of the 1970s and has trended slowly upward since
then. It now stands at about 40 percent. The market share gains reflect the increased
responsiveness and cost effectiveness of U.S. railroads in the post-Staggers era.
•Railroads have improved their financial performance considerably. The average
rate of return on net investment for Class I U.S. railroads — which had been
falling for decades — rose from an annual average of 2.0 percent in the 1970s to
4.4 percent in the 1980s and 7.0 percent from 1990-1999.
•Rail investment has reached levels that would have been unimaginable prior to
Staggers. From 1980 to 1999, U.S. Class I railroads alone spent more than $263
billion — 45 percent of operating revenue, on average — on infrastructure and
equipment. They are committed to spending billions more in the years ahead to
help ensure they have the capability to offer high quality, cost-effective service.
•Railroad accident, employee injury, and cargo loss and damage rates are all down
about 70 percent since Staggers, thanks in large part to the massive investments in
plant and equipment (which have had a definitive safety-enhancing component).
The chart below illustrates the remarkable gains U.S. railroads have made under
the current regulatory regime..Association of American Railroads Page 6 of 1
4 Curtis Grimm and Clifford Winston, “Competition in the Deregulated Railroad Industry: Sources, Effects,
and Policy Issues,” in Deregulation of Network Industries: What’s Next,” (AEI-Brookings Joint Center for
Regulatory Studies, September 2000), p. 44.
The reforms engendered by the Staggers Act have been an extraordinary and
incontrovertible success. The flexibility Staggers provided has enabled U.S. railroads to
rationalize their systems; reinvest in productive rail infrastructure; generate greater
volumes of traffic and higher levels of service; dramatically increase productivity;
improve profitability from once anemic levels; and improve safety, while at the same time
sharply lowering rates for shippers.
All of this has directly benefited rail customers. As Clifford Winston and Curtis
Grimm recently wrote, “[D]eregulation was not just a boon for the rail industry. Shippers
benefited too. Based on the first decade of deregulation, one study found that the annual
benefits to shippers from lower rates and improvements in service time and reliability
amounted to at least $12 billion (1999 dollars).”4
Railroad Competition
As described above, the Staggers Act allowed the U.S. rail industry to become a
competitive factor in the transportation marketplace. The regulatory system it spawned
relies on market competition to govern rail rates and service, and at the same time,
provides regulatory protection against the abuse of railroad market power.
Nevertheless, in both Canada and the United States some groups claim that railroads do
not face effective competition. Instead, these groups claim, railroads today have too
much market power. These groups often point to the number of railroads serving a
particular location to make their point, claiming that excessive market power should be
presumed to exist any time an individual shipper or receiver is served by a single railroad.
Such a presumption rests on the fallacy that service to a single shipper by a single railroad
is equivalent to monopolization. As a point of fact, North American railroads face
extensive competition for the vast majority of their business, including cases where a
shipper is served by only one railroad.
Rail competition can take many forms. Rail-to-rail competition is one such form for
many shippers. In the United States, for example, BNSF and UP compete fiercely over
the Los Angeles to Chicago corridor, among many others, while CSX and NS battle head-to-
head for traffic up and down the Eastern seaboard. In Canada, it is undeniable that CN
and CP compete intensively throughout the country. (This competition is made even
more intense by the use of interswitching and other access provisions available under
existing Canadian law.) In addition, of course, Canadian railroads also compete
extensively against their U.S. counterparts in many markets. Export traffic to the Pacific
Northwest is just one example. In short, in both Canada and the United States, shippers
are continually exercising their options to play one railroad off against another.
More broadly, railroads everywhere compete not just among themselves, but in.Association of American Railroads Page 7 of 1
5 Transportation Table, National Climate Change Process, Foundation Paper on Climate Change:
Transportation Sector (December 1998), p. 17.
6 Andrew Shea and Joseph Schulman, Lower Rates and Improved Performance, (The Conference Board of
Canada, February 2000), p. 5.
7 Analysis and Modelling Group, National Climate Change Process, Canada’s Emissions Outlook: An
Update (December 1999), p. C-22.
the larger market for freight transportation services. As such, they face extensive
competition from trucks and, depending in part on geography, water carriers and/or
pipelines for their traffic. The rail share of intercity freight traffic is a vivid illustration of
the intensity of this competition. In the United States, rail’s share of intercity freight
revenue is only around 10 percent, despite the fact that railroads provide around 40
percent of the transportation service as measured by ton-miles. The U.S. rail revenue
share is down from 31 percent in 1965. In Canada, railroads account for some 63 percent
of ton-miles 5 , but only receive some 24 percent of transportation revenue.6
Rail customers also take advantage of product competition, which refers to the ability of
shippers and receivers to substitute one product for another in their production process.
Coal transported to electric utilities is a good example. Although coal for use in
electricity generation is a critical commodity for U.S. railroads, some 44 percent of the
electricity generated by utilities in the United States is produced from fuel sources other
than coal and, in fact, competes against coal-fired generation. In Canada, most rail coal
movements are for export; domestic movements to power plants are limited by the fact
that some 84 percent of the electricity generated by Canadian utilities is produced from
fuel sources other than coal.7
Geographic competition, which refers to the ability of shippers and consignees to buy
from or sell in any number of geographic areas, also constrains railroads in many markets.
This source competition extends to both domestic and international commerce, an
important consideration for economies like Canada’s that rely so heavily on exports. Just
as coal or grain buyers in Illinois can rely on sources in several different states, coal or
grain buyers in Japan can purchase their products from Canadian or, say, Australian
sources. It is hardly in the best interest of a U.S. railroad serving an Indiana coal mine or
an Iowa grain elevator to price its transportation service so high as to make that coal or
grain uncompetitive at destination compared to coal or grain sourced from different states
and transported by another carrier. Likewise, it makes no sense for Canadian railroads to
price their transportation service so high as to make Canadian products uncompetitive on
the world market. It strains credibility to claim that this kind of pressure does not
effectively constrain railroad rates in a multitude of markets, including markets served by
a single railroad.
And, of course, railroad customers frequently possess extensive countervailing
market power. This is particularly true of large, sophisticated companies with multiple
locations. As only one example, these companies can obtain price or service concessions
by shifting or threatening to shift traffic among plants — causing the railroads that serve.Association of American Railroads Page 8 of 1
8 Clifford Winston, “You Can’t Get There From Here: Government Failure in U.S. Transportation,”
Brookings Review, Summer 1999, pp. 37-49.
them to compete against each other. Indeed, some individual rail customers rival or
exceed the size of the entire rail industry.
A fundamental principle of the economics of regulation is that regulators should
not intervene in markets where competition is reasonably effective. This is especially
true in railroad markets, where regulators’ past performance (as evidenced in the United
States in the pre-Staggers period) left so much to be desired. A prominent economist was
certainly correct when he recently wrote, “The preponderance of scholarly evidence
developed in transportation economics over the past several decades leaves no question
that the government should greatly reduce its role in all aspects of transportation.”8
Differential Pricing
Many of the same groups that wrongly claim that railroads in North America are
monopolies also call for limiting the railroads’ price-making freedoms. The primary
rationale for these groups is the false notion that railroads abuse their market power by
charging higher rates to shippers with fewer transportation options than to shippers with
more transportation options.
A railroad must balance the desires of each customer to pay the lowest possible
rate with the requirement that the overall network take in enough money to keep it
functioning now and into the future. The best way that anyone has developed for rail-roads
to do this is through the use of “differential” (sometimes called “demand-priced”)
pricing. Differential pricing is not an abuse of market power. Rather, it is a pricing
technique commonly practiced by competitive industries throughout the United States
and Canada, including by many of those who want to prevent its use by railroads. Absent
government subsidies, differential pricing is essential to railroads’ financial viability.
This is so because of the cost and demand characteristics freight railroads face.
On the cost side, railroads have extremely high fixed costs (e.g., the track structure and
related facilities) that must be covered regardless of traffic level. On the demand side,
rail shippers differ widely in terms of their willingness to pay for rail service. On one
extreme, some rail traffic can easily shift to truck or other alternatives, and would do so if
railroads charged much over their variable cost of moving that traffic. On the other
extreme, some rail traffic is less easily diverted to other modes and has fewer competitive
alternatives; this traffic can be charged higher markups to reflect the attendant higher
demand for rail service.
Given this demand structure, railroads would lose customers if they were required
to charge all traffic the same markup over variable costs. Instead, railroads price their
services on the basis of demand, with those shippers with the greatest demand for rail
service paying higher markups than shippers with lower demand. This way, railroads
cover their variable costs and realize varying contributions to fixed costs from the greatest.Association of American Railroads Page 9 of 1
number of customers.
Differential pricing benefits all shippers because lower rates to some shippers
generate revenue (helping to cover fixed costs) which otherwise would not be realized.
Indeed, given their demand structure, only by pricing in accordance with demand (with
reasonable regulatory ceilings on maximum rates) can railroads efficiently recover all of
their costs, serve the largest number of rail customers, and maintain the viability of a
nation’s rail system. (See Appendix A for a simplified example of the dynamics of
differential pricing.)
Unfortunately, many of the proposals to reregulate the railroads — again, in both
Canada and the United States — would gut the use of differential pricing by railroads.
Manufactured rail-to-rail competition would artificially drive down rail rates to the point
that full cost recovery would not be possible. There would no longer be a sufficient mix
of high demand-high margin and low demand-low margin traffic to enable railroads to
earn the total markups they need to cover their full costs.
It is axiomatic that no industry can sustain itself if it cannot produce income
sufficient to cover full current and future costs. Yet no proponent of restricting the use of
differential pricing by railroads in the United States, or, as far as I am aware, in Canada,
has convincingly explained how the resulting enormous revenue shortfall could be made
up. If unable to price differentially, over time a railroad would have to reduce its costs —
perhaps through neglecting maintenance that otherwise would be performed, perhaps
through reducing the frequency or quality of service, perhaps through foregoing the
acquisition of new equipment or some other means. Eventually, the railroad would reach
a stage where it would become economically rational to begin shedding traffic. Such a
result is certainly not in the public interest, since shippers would lose rail service, nor is it
what would occur under market-based pricing decisions.
Rail customers are not always "happy" with the prices they are able to negotiate
with the railroads. Virtually every purchaser of goods or services, including railroads,
would like to get a better deal than what they have from their suppliers. But there is no
question that the vast majority of railroad rates, in both Canada and the United States, are
market-based and driven by competition.
Railroads and Investment
As recounted earlier, the United States offers a stark reminder of what happens
when a rail system is starved for capital. Prior to passage of the Staggers Act, rail
investment was woefully deficient. In the 1970s, when most rates were set by
government fiat and return on investment averaged two percent, U.S. railroads simply
lacked the ability to invest at adequate levels. There was little doubt at the time that
inadequate investment was a major factor contributing to the railroads’ financial distress
and unsatisfactory service. As Congress explained, “The simple fact of the matter is that
the railroad industry is a capital-intensive industry which for decades has had inadequate.Association of American Railroads Page 10 of 1
9 Staggers Rail Act of 1980, H.R. Rep. No. 96-1430, 1980, p. 95.
earnings to maintain its plant and facilities at a level necessary to achieve improved
services.”9 Indeed, in 1980, Congress acknowledged the enormous capital shortfall ($16
to $20 billion by 1985) of the railroad industry, even after billions of dollars of
emergency federal funding had flowed into the bankrupt Northeast railroads.
A similar situation occurred in Canada. By freezing the rates for the movement of
grain in western Canada at the levels that prevailed in 1897 (the Crow Rates), the federal
government was forced to spend billions of dollars to subsidize grain transportation in the
1970s and 1980s because the railways simply could not afford to invest in the grain
transportation system. These government programs included the rehabilitation of branch
lines, the purchase of a large fleet of covered hopper cars and the payment of subsidies to
the railways to compensate them for their losses from the operation of branch lines.
Deregulation via the Staggers Act gave U.S. railroads the means and incentive to
invest. By granting railroads pricing freedoms and providing them the opportunity to
earn revenues sufficient to cover their ongoing cost of operations, deregulation sparked an
industry transformation. As income increased, so did investment.
The capital intensity of freight railroads is immense. In fact, freight railroad
capital expenditures on plant and equipment as a percentage of revenues is greater than in
any other major industrial sector. U.S. Class I railroad revenues reached $33.5 billion in
1999. Of that, railroad capital expenditures were $6.6 billion, or 20 percent, more than
five times the comparable figure for other industries. Maintenance expenses on right-of-way
and equipment maintenance add another $10 to $12 billion in rail spending each
year. This extraordinary level of funding is required year after year to provide the high
quality assets necessary for the rail industry to operate efficiently, and has made the
nation’s railroads stronger and more effective competitors. Importantly, unlike other
transportation modes, railroads rely on private financing, not government funds, to pay
for their infrastructure investments.
Further, compared on the basis of total assets required per dollar of revenue produced,
U.S. railroads have significantly higher asset needs — $2.57 of assets for each dollar of
revenue produced in 1999 — than other major U.S. industries. (The picture is basically
the same for Canadian railroads compared to other Canadian industries.)
Because major U.S. freight railroads receive no appreciable government funding, they
must earn enough year after year to cover these massive spending requirements.
However, the industry’s internal cash flow is not enough to sustain the capital investment
railroads require. In fact, U.S. railroads must access the outside capital markets every
year to fund their investment needs. From 1981 to 1999, of the cumulative $81.9 billion
in capital expenditures by U.S. Class I railroads, approximately 64 percent was provided
from internally-generated funds and 36 percent from external capital providers..Association of American Railroads Page 11 of 1
Ratio of Assets to Revenues
of Fortune 500 Firms for Selected Industry Groups: 1999
Industry
Number
of Firms
Total
Revenues
($ billions)
Total Assets
($ billions)
Ratio of
Assets to
Revenues
Chemicals 15 $114.4 $162.1 1.42
Food 22 178.6 116.2 0.65
Forest & Paper Products 11 106.3 134.0 1.26
Industrial & Farm Equipment 11 81.2 88.3 1.09
Metals 8 44.2 54.6 1.24
Mining, Crude Oil Production 3 17.0 24.6 1.45
Motor Vehicles & Parts 14 452.8 634.6 1.40
Railroads 4 36.4 93.6 2.57
Trucking 2 8.8 4.4 0.50
Gas & Electric Utilities 37 266.3 594.8 2.23
Total 127 $1,306.0 $1,907.2 1.46
Source: Fortune, April 17, 2000 pp. F-1–F-20.
The Dangers of Reregulation
It is worth repeating the essential point that artificial and unrealistic restrictions
that impede a railroad’s opportunity to generate sufficient returns will severely
compromise a railroad’s ability to retain and attract the capital it needs to sustain its
investment and operations over the long term.
Access to capital is more important than ever to the rail industry for two reasons.
First, only through increased productivity have Canadian and U.S. railroads been able to
increase their profitability in recent years in the face of strong competition from trucks
and declining rail rates. Those productivity gains, however, were achieved through
measures that have largely been exhausted or through one-time events — as some have
put it, by picking the “low-hanging fruit.” Future productivity gains will likely need to be
“purchased” with additional, large-scale strategic infrastructure investments.
Second, new investment is also needed to meet increasing shipper demand for
transportation service. In the United States, rail traffic as measured by revenue ton-miles
has increased by 57 percent since 1980, including 39 percent in the 1990s. In Canada,
revenue ton-miles have increased by 29 percent in the 1990s. Part of this growth has
been fueled by the increasing globalization of commerce and the resulting increase in
demand for high-volume, long-haul transportation that is well suited to railroads.
This globalization is vividly reflected in North American trade statistics.
According to U.S. and Canadian government data, for example, both Canadian exports to
the United States and Canadian imports from the United States have more than doubled
in the past ten years alone, totaling more than $360 billion in 1999. Over the past five
years, the United States has accounted for some 67 percent of all Canadian imports and
83 percent of Canadian exports. Canada is by far the largest U.S. trading partner, larger.Association of American Railroads Page 12 of 1
10 Anthony B. Hatch, independent railroad analyst, in speech before the American Short Line and Regional
Railroad Association, September 14, 1999.
11 Grimm and Winston, p. 45.
even than the entire European Union, and commerce between Mexico, Canada and the
United States is increasing the global competitiveness of North America. Roughly one-fifth
of the freight flow, as measured by value, travels by rail. Thus, laws and regulations
that impair the cost-effectiveness of railroads likewise threaten the efficient flow of trade
between the two countries. Indeed, given the success of the North American Free Trade
Agreement in enhancing trade between Canada, the United States and Mexico, actions
that harm railroads could potentially disrupt trade throughout North America.
In short, railroads must be able to offer investors returns comparable to what the
investors could expect if they invested their funds elsewhere at comparable risk. As one
investment banker recently put it, “Capital flows to the areas of highest return. If … new
regulations change the rules of the game and ensure poor returns, then the Street will
disinvest, (or further disinvest) causing managements to begin to reallocate cash and
begin “harvesting” the business. They will have no choice.”10
I submit to you that it is hardly in the interest of your nation or mine to set in motion the
“harvesting” of our rail networks.
It is hard to see any alternatives, though, given the amount of revenue railroads could be
expected to lose through various regulatory changes. The Grimm/Winston study noted
earlier, for example, which focused on a limited set of shippers, found that artificially
manufactured rail competition would result in a drain to the railroads of $1.3 billion
annually.11 The study also concluded that this huge loss of revenue to the railroads would
provide no benefit to the economy, since it would merely be a transfer from railroads to
rail customers.
Meanwhile, rail industry analysis of specific reregulation proposals reveals that $3.3
billion or more in railroad revenue could be lost annually. Because the revenue loss
would not be accompanied by compensating reductions in expenses, most or all of the
industry’s net income would disappear.
Ultimately, the only realistic alternative to disinvestment is for the government to
step in and provide subsidies to railroads to make up for the lost revenue. The United
States and Canada are two of the very few countries in the world that offer first-level
freight rail service and do so without massive government subsidies. Whether inserting
the government in a caretaker role is appropriate for either of our countries is ultimately a
public policy question to be determined by each country. However, neither country
should be under the illusion that denying railroads the opportunity of earning adequate
revenues means something other than disinvestment or increased government subsidies.
Excessive railroad regulation that leads to disinvestment is also antithetical to.Association of American Railroads Page 13 of 1
12 U.S. Environmental Protection Agency, "Emission Standards for Locomotives and Locomotive Engines:
Proposed Rule," Federal Register, February 11, 1997, p. 6368.
13 Transportation Table, National Climate Change Process, Transportation and Climate Change: Options
for Action (November 1999), pp. 19, 26.
sound national transportation policy that should recognize freight railroad advantages in
energy efficiency and pollution abatement. On average, railroads are around three times
more fuel efficient than trucks, and railroad fuel efficiency is improving all the time. In
1990, for example, U.S. railroads moved a ton of freight an average of 332 miles per
gallon of fuel consumed. In 1999, the comparable figure was 386 miles, a 16 percent
increase. In Canada, fuel efficiency rose 18 percent over the same period.
Further, the U.S. Environmental Protection Agency (EPA) estimates that for every
ton-mile, a typical truck emits roughly three times more nitrogen oxides and particulates
than a locomotive.12 Other studies suggest that trucks emit six to 12 times more
pollutants per ton-mile than do railroads, depending upon the pollutant measured. And
railroads have a decided advantage in terms of greenhouse gas emissions. In Canada,
diesel trucks generate nearly six times more greenhouse gas emissions than railroads per
ton mile of freight transported. Railroads account for just four percent of transportation-related
greenhouse gas emissions in Canada.13
Reregulation Will Not Enhance Efficiency or Reduce Costs
Proponents of railroad reregulation in the United States claim that the introduction
of forced rail-to-rail competition wherever it does not now exist would cause railroads to
enhance their attractiveness to shippers, leading railroads to increase their investment in
plant and equipment in an effort to win the business away from the new competitors.
Proponents of railroad reregulation claim that the added competition for rail
traffic would reduce rates, but reduced rates would increase volume. Cost reductions and
innovations would purportedly produce benefits that improve efficiency and productivity,
and restore the margins and profitability needed to support infrastructure investment.
Thus, they say, no rail disinvestment need occur and rail profitability need not suffer.
The claim that additional forced rail-to-rail competition will lead to reduced
railroad costs, increased innovation and enhanced efficiency in the United States (or
Canada, for that matter) rests on the pivotal assumption that today’s railroads have
“grown fat” due to the excessive market power they allegedly possess. Yet there is no
evidence that this is true. In fact, the empirical evidence points squarely to the opposite
conclusion:
•Productivity: If railroads had excessive market power and had “grown fat,”
incentives to reduce costs and use productive inputs efficiently would be
suppressed. Yet according to the U.S. Bureau of Labor Statistics, railroad
productivity has exceeded that of nearly every other U.S. industry over the past
decade, and rail costs per unit of traffic have plunged. There are many common.0.0¢
0.5¢
1.0¢
1.5¢
2.0¢
2.5¢
3.0¢
3.5¢
1981 1983 1985 1987 1989 1991 1993 1995 1997 1999
Class I Railroad
Revenue Per Ton-Mile, 1981-1999
Source: AAR
Current $
Constant 1981 $
Association of American Railroads Page 14 of 1
ùáøó ôï µåáóõñå ðñïäõ÷ôé.éôø,áíä áëë ïö ôçå µóçïù óõâóôáíôéáë
é µðñï.å µå ô.Öïñ åîá µðëå,ñå.å õå t..-µéëåó ðåñ å µðëïøåå öïñ Õ.Ó.
ñáéëñïáäó ñïóå 287 ðåñ÷å ô öñï µ 1980-1999,éí÷ëõäé ã 69 ðåñ÷å ô óéí÷å 1990.
Éí ×áíáäá,ôçå ÷ï µðáñ able figure rose 97 percent from 1990-1999.
•Prices: The exercise of market power rarely involves sharply lower prices, while
a sharp reduction in prices usually signals powerful competitive constraints at
work. Overall U.S. rail revenue per ton-mile has fallen substantially and
continually — by 28 percent in
nominal terms and 57 percent
in inflation-adjusted terms —
since 1980. These rate
reductions have occurred
across commodities lines,
across mileage blocs, and for
both railroad- and non
railroad-owned cars. These
sharp rate reductions are a
direct result of the pass-
through to shippers of
railroads’ massive productivity
gains made possible by partial
economic deregulation and
made necessary by the intense competition railroads already face. Revenue per
ton-mile has also fallen dramatically for Canadian railroads.
•Innovation: If railroads had excessive market power, their incentives to invest in
innovative products and processes would be reduced. But unit trains, double-
stacking intermodal freight cars, grain car reservation systems, AC locomotives,
modern dispatching centers, improved safety equipment, e-commerce initiatives,
and a variety of other innovations attest to the railroads’ competitive incentives.
•Investment: If railroads had “grown fat,” incentives for investment would be
reduced. But in the 1990s alone major U.S. freight railroads have invested nearly
$140 billion to maintain and improve their infrastructure and equipment. Capital
expenditures per mile of road owned were more than $66,000 in 1999, almost 2 ½
times the comparable inflation-adjusted 1983 figure. These investments have
occurred across the rail network and have benefited all rail sectors, not just the
most highly-competitive markets.
•Market Share: If railroads had excessive market power, they would not have
steadily lost market share for decades. The ongoing struggle by railroads to retain
the meager market share gains they have made over recent years is stark evidence
of the intensity of the competition they face from other modes. For example, only
about 15 percent of total U.S. electricity generation is accounted for by coal-fired.Wyoming* Coal Production: 1971-1999
(Millions of Tons)
0
50
100
150
200
250
300
350
71 73 75 77 79 81 83 85 87 89 91 93 95 97 99
*Used as a proxy for the PRB. Source: Wyoming State Geological Survey
Association of American Railroads Page 15 of 1
ðëá ôó óåñ.åä .õóô âø á óéíãëå ñáéëñïáä.Ëéêåùéóå,Õ.Ó..åðáñô µå ô ïö
Áãñé÷õëôõñå äáôá éíäé÷ ate that trucks have supplanted railroads as the primary
transportation mode for grain. And the U.S. chemical industry’s own figures show that
railroads account for just 20 percent of chemical transportation tonnage.
•Profits: If railroads had excessive market power, they would be able to earn more
than a competitive rate of return. But no one can seriously argue that railroad profits in
either Canada or the United States are excessive. In the United States, railroads
consistently fail to earn their cost of capital and rail profitability has for many years
consistently ranked in the bottom quartile among all U.S. industries.
The Powder River Basin Example
When pressed for specifics to buttress their claim that manufactured rail-to-rail
competition will lead to efficiency, lower costs, and higher investment, proponents of
railroad reregulation often cite the supposed example of the Powder River Basin (PRB) in
Wyoming and southern Montana. According to their version of the PRB tale, the
introduction of increased rail competition into the PRB in the form of the Chicago and
North Western (now part of Union Pacific) in the mid-1980s forced the incumbent PRB
carrier at the time, Burlington Northern (BN), to increase investment and raise
productivity. Today, the story goes, both carriers are better off because of competition for
Powder River Basin traffic.
This version of the PRB story badly confuses cause and effect. In fact, the PRB
example lends no support to the claim
that mandated rail-to-rail competition
would not harm railroad profitability
or investment. The CNW/UP entry in
the PRB was spurred by the enormous
potential market for PRB coal, a
market that has certainly come to pass
(see chart). Thus, CNW/UP’s
investment in the PRB was, and still
is, prompted by the opportunity for
adequate returns. For BN, that
opportunity would have been there
without the introduction of additional
railroad competition.
It so happens that the PRB can sustain two railroads. But claiming that every
market can sustain two railroads just because the PRB can is like saying that every city
can support two major league baseball teams just because New York can. This same
point was made by Alfred Kahn, the prominent economist, who said in reference to air
service in Ithaca, New York, where he lives, “We can’t all have two or three airlines
vying for service to Ithaca. The Ithaca market won’t support a lot of competition. If you.Association of American Railroads Page 16 of 1
14 Quoted in National Journal, April 10, 1999, p. 953.
want the benefit of choice, you might have to go 50 miles away.”14
Thus, the central lesson of the PRB is not that added competition yields profits
anywhere, without regard to demand and cost considerations. Rather, the central lesson is
that rail-to-rail competition develops where the capital markets have found that returns
justify it. Stated another way, it is not economically feasible for there to be two railroads
serving every shipper, because that level of competition is not sustainable. Trying to
mandate it, through regulation, is bound to be self-defeating.
Forced Access
As noted earlier, a number of different proposals have been offered in both the
United States and Canada that would modify the structure of economic regulation of
railroads. One such proposal is the imposition of so-called “open access.” This proposal,
which is more accurately labeled “forced access,” would allow any railroad to run its cars
over virtually any track, regardless of who built, paid for or maintained that track. Forced
access has been mentioned in the United States, but is not at the forefront of reregulation
proposals; that is not necessarily the case in Canada, where a number of groups
(including, for example, the Canadian Wheat Board) view forced access as a legitimate
and workable alternative to the existing system of economic regulation.
Like other reregulation proposals, forced access is an attempt by a segment of
shippers to gain lower rail rates at the expense of other rail shippers, rail employees, rail
investors and the public at large. This would be accomplished by unreasonably
modifying existing regulations that already protect shippers against unreasonable rates
and anticompetitive rail practices. Thus, forced access spawns more regulation, not more
competition. Given that rail deregulation has been an unqualified success in both the
United States and Canada, this makes no sense.
The present level of rail competition reflects real world decisions as to which
markets will sustain multiple railroads and which will not. Trying to artificially create
more competition than the marketplace will support would reduce railroads’ ability to
compete against each other and against other modes, because it would prevent them from
earning enough to cover the full cost of providing infrastructure, equipment, and safe rail
service across their entire system.
Under forced access, the setting of rates and priorities for use of the track, as well
as establishing other operating conditions, service levels, interchange conditions, yard
usage and other elements necessary to provide safe and effective rail service would move
from the private sector rail owner to the government or a manager empowered by the
government to regulate the system. Forced access would make it more difficult to operate
safely, efficiently and profitably, due to governmental interference, transaction
complexity and lack of coordination between railroad owners and operators. Complex,
lengthy and costly disputes over terms of use would be inevitable. Indeed, at times it can.Association of American Railroads Page 17 of 1
15 Marc Ivaldi and Gerard J. McCullough, Density and Integration Effects on Class I U.S. Freight
Railroads (Paper prepared for the Association of American Railroads, April 1999.)
be difficult enough for a vertically integrated firm with control over all aspects of rail
operations to oversee their coordination. To inject additional layers and complexities
would make the task immeasurably more difficult and costly. In both Canada and the
United States, control by integrated railroads of all the elements of rail transportation has
resulted in huge productivity gains and huge cost savings, but forced access would negate
these gains.
Some of these issues were explored in a recent study that found that Class I railroads
experience significant returns to density. The study found that if the effect of forced
access requirements were to reduce densities, the unit cost of providing freight service
would increase. The study also confirmed that the marginal costs of various freight rail
operations are less than average variable costs, which implies that railroads should be
allowed to charge differential prices in order to ensure continued rail investments.
Finally, the study confirmed that there are significant cost relationships between railroad
freight operations and infrastructure maintenance activities, suggesting that there would
be significant coordination and congestion problems to resolve if forced access led to a
separation of operating entities and infrastructure entities.15
In the short run, forced access might indeed lead to lower rates for a small group
of favored shippers. In the long run, however, it would cause significant harm because it
ignores the realities of rail economics. Because forced access is premised upon lower-than-
market rates, it would prevent railroads from earning sufficient revenues to reinvest
in their systems, with the inevitable result that the existing rail network would shrink —
at a time when the growing North American economy needs efficient rail transportation
more than ever. Private investors would commit far less money to such a rail system,
because operators could appear at any time and reap the economic benefit of the
investments made by the track’s owner.
Access Pricing
Under forced access, a tenant railroad would pay a fee to the owning railroad for
use of the owner’s assets. Proposals that I have seen first look to voluntary negotiations
between the owner and the tenant to set the access price. In most cases, however, these
negotiations are not likely to be successful, because if the owner believed that allowing a
tenant access was prudent, he would allow access voluntarily and would not need to be
forced to do so.
Under existing U.S. railroad rate regulations, maximum rates for any one shipper
can be no greater than what would be required by an efficient, hypothetical competitor.
Capping rates in this manner is consistent with economically-efficient coverage of fixed
costs. If the owning railroad is as or more efficient than a potential tenant, the tenant
could not charge a lower rate and still pay for the investments necessary to serve the
shipper. Under forced access, rates would fall only if the current rate reasonableness.Association of American Railroads Page 18 of 1
standards were changed, allowing a tenant to provide service without paying the
appropriate rental for all the investments necessary to serve the shipper.
If, after taking into account all relevant factors — including the increased
operational complexity of multiple operators — the potential tenant is more efficient than
the owning railroad, there could be a lowering of rates even after an appropriate rental is
paid. Where that condition exists, it is already in the owner’s interest to grant the rights
voluntarily. Indeed, when the market deems it economically efficient to do so, railroads
commonly contract among themselves to share resources.
For example, railroads have entered into numerous trackage rights and haulage
agreements, jointly operate and use terminals and dispatching facilities, jointly market
and perform innovative services, share the ownership of switching and terminal railroads,
perform reciprocal switching for each other, and pool freight cars. Such inter-corporate
alliances are common not only among railroads, but also between railroads and motor
carriers, freight consolidators, steamship interests and others. Unlike the forced sharing
of assets contemplated by various compulsory access proposals, these arrangements
represent a voluntary sharing of facilities which are deemed by the participants to be
mutually beneficial.
It is worth noting that the U.S. government has a woeful record in setting
appropriate access charges. For example, the fees (in the form of various taxes and user
fees) paid by rail-competitive trucks in the United States fall far short of covering the
damage to highways the trucks cause, and the fees paid by barges fall far short of the cost
of inland waterway construction and maintenance.
Other Industries Are No Models
Proponents of railroad reregulation deny that they want to reregulate railroads. In
fact, they claim that all they want is further deregulation of the railroads. They point to
the deregulation of the electric utility, telecommunications, and natural gas industries as
models of the alleged "deregulation" they want for railroads.
Of course, it is not at all clear at this point how well the “deregulation” has
worked in these other industries, or even if “deregulation” is an appropriate term to use.
In telecommunications, for example, various issues have been tied up in the courts for
years, and will continue to be for years to come. In electricity, various states are trying
various approaches, not all of which have gone smoothly, as electricity consumers in San
Diego can attest.
As a point of fact, the electricity, natural gas and telecommunications industries
are not appropriate models for railroads. On the contrary, it is more accurate to say that
railroads are models for them, in that railroads have already achieved many of the goals
that proponents of deregulation in these other industries seek to achieve..Association of American Railroads Page 19 of 1
First, “open access” in other industries does not prevent these industries from
recovering their total costs. U.S. electricity transmitters, for example, are still governed
by traditional rate-of-return regulation and are essentially guaranteed to recover their full
costs, including an adequate return on investment. By contrast, as explained elsewhere in
this paper, under various access regimes being proposed for railroads, railroads would be
unable to recover total costs.
Second, “open access” in the other industries means that transmitters become, in
essence, common carriers. In the United States, for example, owners of electric
transmission lines are now generally required to transmit electricity generated by any
producer. Likewise, cable companies offering Internet access have come under pressure
to offer their subscribers competing Internet service providers (ISPs). In both cases, the
other industries are being asked to do what railroads have been doing for decades. The
various electricity generators and the various ISPs are like competing coal companies on a
railroad’s line. As a common carrier, by law a railroad cannot say that it will carry Coal
Mine A’s traffic but not Coal Mine B’s. The railroad has to carry both, if both request it.
A coal consumer — say, a coal-fired power plant — is free to burn Mine A’s or Mine B’s
coal, and the railroad has to bring that coal to that plant. Thus, open access in the other
industries takes them to where railroads already are.
Third, other industries were, by and large, inefficient monopolies with guaranteed
customer bases and financial returns. Open access in those other industries holds the
potential to promote efficiencies and lower costs, increase innovation and improve
service. Railroads have faced intense competition for decades and have already achieved
these goals, as discussed earlier.
Fourth, in the other industries, monopoly control over bottlenecks gave vertically-integrated
firms the ability to favor their own products over competitors. For example, a
vertically-integrated electric utility could use its ownership and control of transmission
lines to favor electricity produced by its own generating plants, at the expense of
electricity generated by others, even if the other electricity producers were more efficient.
The situation is vastly different for railroads. Importantly, railroads do not produce or
own what they are transporting. They are transportation providers only. Also, under
existing regulation, end-to-end rail rates are limited to what an efficient competitor would
charge, meaning there is no potential for monopoly railroad profits. Finally, railroads
controlling a bottleneck, in contrast to firms controlling bottlenecks in the other
industries, have no incentive for “self-dealing.”
Fifth, unlike utilities, railroads were built only where competitive capital markets
supported building them. Sometimes this meant shippers were served by more than one
railroad, sometimes not. In any case, competition has been determined by the market.
That's certainly not how many utilities were formed and developed.
Finally, other industries involve fungible products (e.g., electric current for
electric utilities, natural gas). By contrast, railroads must move specific commodities in.Association of American Railroads Page 20 of 1
16 Louis S. Thompson, World Bank Railways Adviser. Quoted in the Journal of Commerce, July 29, 1998.
specific railcars to specific locations. The consequent distributional complexities for
railroads are orders of magnitude higher than for these other network industries.
It is interesting to note that regulators and legislators are doing something for
electric utilities that is certainly not being considered for railroads by proponents of
railroad reregulation. If enhanced access in the electric utility industry results in assets
becoming underutilized or unnecessary — “stranded” is the word being used to describe
this phenomenon — the utility gets its investment back.
Given all this, perhaps the most appropriate question to ask when comparing
railroads with these other networked industries is, when are they going to become more
like railroads?
Lessons From Other Countries
Just as proponents of railroad reregulation wrongly point to the experience in
other industries as models for railroad regulation, so too do they sometimes wrongly point
to the experiences of rail systems in other countries as “proof” that their regulatory
proposals have merit for Canada and the United States.
North American railroads are the undisputed world leaders in efficient, low-cost
freight railroad operations. According to World Bank data, the Canadian and U.S. freight
railroad industries lead the world (often by extremely large margins) or are near the top
among all countries in terms of size, volume, productivity and affordability. Such
leadership is no accident. It is directly a function of predominantly market-based
operations, which provide incentives for continuous improvement in productivity and
service levels.
In both the United States and Canada, the rail model is of “vertical integration,” in
which a railroad company both owns the track and affiliated infrastructure and also
controls the operation of trains moving over the track. In both the United States and
Canada, vertical integration has resulted in huge post-deregulation productivity gains,
massive reinvestment in infrastructure by the railroads themselves, and sharply lower rail
rates that have saved shippers billions of dollars per year. The World Bank’s Lou
Thompson notes that, “Because of a market-based approach involving minimal
government intervention, today’s U.S. freight railroads add up to a network that,
comparing the total cost to shippers and taxpayers, gives the world’s most cost-effective
freight service.”16 Canadian railroads closely mirror the value provided by U.S. carriers.
In recent years, countries in every corner of the globe have commercialized and
restructured their freight rail systems, with a goal of minimizing (not augmenting)
government involvement, significantly improving the competitiveness of rail freight
systems, and slashing government subsidies. To do this, they have looked to North
America for guidance. Indeed, as noted in the attached recent report by Mercer.Association of American Railroads Page 21 of 1
17 Mercer Management Consulting, Inc., before the Surface Transportation Board, Review of Rail Access
and Competition Issues, March 25, 1997.
Management Consulting (one of the world’s leading transportation consultancies,
involved in around 90 percent of the global rail restructurings in recent years), the most
successful restructurings have imitated the North American model, not diverged from it.
To be sure, a few countries have experimented with the forced access model, in which
multiple railroads have operating rights over rail right-of-way that they do not own, on the
theory that it would promote more rail-to-rail competition and achieve other restructuring
goals. In each case, the track infrastructure is still a monopoly in the hands of a single
owner. Further, where it has been implemented, including Australia, Sweden and the
United Kingdom, intra-rail competition has been slow to develop. In the United
Kingdom, for example, British Rail was sold as six separate freight concessions, but all
but one have re-emerged as a single railroad. In Australia, the new entrants primarily
have either been intermodal specialists, focusing on specific markets, or successors to the
government-owned operations.
Further, open access has not achieved the goal of reducing subsidies in many
cases. In Sweden, for example, the government unit that owns rail infrastructure will
collect more than $4 billion in public funds from 1998 to 2007, since the access fee for
train operators is essentially zero. In the United Kingdom, government support still
exceeds $3 billion per year, even though subsidies were supposed to decline over time.
Many other countries have considered forced access and rejected it. In Argentina and
Mexico, for example, an “open access” regime was initially considered and met with
overwhelmingly negative responses from potential investors, who were not interested in
committing funds to railroads where competitors could appear at any time and capture the
economic benefits of those investments.
In testimony before the Surface Transportation Board 17 , Mercer compared the
prices paid by buyers of vertically-integrated rail systems in the United States, New
Zealand, and Mexico between 1988 and 1997 with the price paid by English, Welsh &
Scottish Railway (EWS) consortium for the freight concession over the "open access" rail
system in the United Kingdom.
In each vertical integration case, Mercer found that the buyer has paid a multiple
of more than one times the system’s annual revenues. For one of the Mexican
concessions, the purchase price was 7.7 times revenues, even though the buyers knew that
they would have to invest substantial additional sums to bring the infrastructure up to
acceptable condition. In the case of the EWS, however, the price was only 0.4 times
revenues — just 30 to 40 percent of average U.S. values and just five percent of the value
commanded in Mexico.
What accounts for the significant difference in valuations? As Mercer explains, in
vertically-integrated systems an owner can measure and capture the full economic value.Association of American Railroads Page 22 of 1
18 Nick Pigott, “The Persuader (Interview of Alastair Morton),” The Railway Magazine (July 2000), p. 49.
of the business unit it is acquiring. It can match capital outlays with customer demand
and capture the efficiencies which occur when operating decisions are coordinated with
investment decisions. Moreover, without the threat of "cherry-picking" of high margin
traffic by potential competitors, the owner can engage in differential pricing. Just the
opposite occurs in an open access regime, where new entrants can seek to "cherry-pick"
the most profitable business, leaving the owner with lower-margin customers, reduced
profits, and lower capital investment.
This point was recently acknowledged by the chairman of the United Kingdom’s Shadow
Strategic Rail Authority (which is responsible for the strategic planning, coordination and
supervision of the activities of the U.K. rail industry and the disbursement of appropriate
public funds), who said, “We need to be very careful about [open access] because we
can’t expect investment from franchisees whose best routes are being cherry-picked by
others. If the country’s entire network were to become a cherry-pickers’ party, who
would run the low-returning regional lines – nobody!”18
The experience in these countries confirms that in a capital-intensive industry like
railroading, forced access simply entails too much risk for private investment to supply
the massive amounts of capital a functional and efficient rail system requires. Investors
in countries that rejected forced access also recognized that forced access would make it
more difficult to operate a railroad efficiently and profitably, due to government
interference, transaction complexity and a lack of coordination between operational and
infrastructure investments.
Conclusion
The regulatory scheme devised by the U.S. Congress and enacted through the
passage of the Staggers Rail Act of 1980 relies on competition in the marketplace to
govern the vast majority of rail rates and service. The experience since Staggers
demonstrates that there is abundant competition in freight transportation markets which
has allowed this congressional objective to be fulfilled.
For this reason, the AAR believes that the current regulatory regime — under
which competition and market forces are the determining factors in setting rail rates and
service standards in most cases, with maximum rate and other protections available to rail
customers who truly need them — is, by and large, an appropriate one. It strikes a
reasoned balance between providing railroads the freedom to compete effectively in the
marketplace and providing shippers the means necessary to combat actual abuse of
railroad market power and anti-competitive railroad behavior, where it may exist.
The railroad industry does not maintain that the existing mix of competition and
regulation is necessarily perfect. Both U.S. and Canadian railroads are willing to engage
in sincere participation in private sector and regulatory initiatives concerned with service,
safety, and other areas of rail operations to identify particular elements of the current.Association of American Railroads Page 23 of 1
regime that can potentially be improved. That said, the experiences and performance of
the U.S. rail industry before and since the passage of the Staggers Act make it abundantly
clear that a reliance on increased economic regulation of railroads, through the
introduction of artificial competition or any other form, would be a colossal mistake.
Going forward, railroads in both Canada and the United States need the continued
flexibility that deregulation has offered in order to efficiently handle the future
transportation needs of our growing economies and sustain our nations’ international
competitiveness..Appendix A
Association of American Railroads Page 24 of 1
Why Differential Pricing B enefits A ll R ail Shippers
1. Suppose a railroad has fixed costs o f $180 and serves three shippers: a
package delivery company, a grain elevator, and a coal- fired power plant.
The railroad’s variable co st to serve each shipper is $100.
The package company w ill pay no more th an $130 for rail service. At any
higher rate, it will switch to truck. The grain elevator will pay no m ore
than $160 for rail service -- at any higher rate it w ill switch to barge. The
power plant has no real alternative to rail, so it is willin g to pay more -
$190 - fo r rail service. The railroad en gages in differential pricin g to
cover its fixed costs. It charges the package company and the grain
elevator less than the power plant. The railroad covers fixed
and va riable costs, although each shipper m akes a different
contribution to fixed costs.
Differential Variable Contrib ution
Shipper Rail R ate Costs to Fixed C osts
Package company $1 30 $1 00 $3 0
Grain elevator $160 $100 $60
Power p lant $1 90 $1 00 $9 0
Total $4 80 $3 00 $1 80
2. Now, suppose the power plant persuades the government to
prohibit diffe rential rates.* The railroad now must charge each
shipper the s ame markup over variable costs , or $160. At the
new rate, the power p lant saves $30; the grain elevator pays the
same as before, and the package company pays $30 more.
New Variable Contribution Change From
Shipper Rail R ate Costs to Fixed C osts Diff. R ate
Package company $1 60 $1 00 $6 0 +$ 30
Grain elevator $160 $100 $60 $0
Power p lant $1 60 $1 00 $6 0 -$ 30
Total $4 80 $3 00 $1 80 $0
3. But a t a rate of $160, the packa ge company w ould d ro p rail
service. W hen it did so, the railroad’s $180 in fix ed costs would
still need to be covered. So, the railroad must then charge the
grain elevator and the power plant $190 each in order to cover
tota l c osts.
New Variable Contribution Change From
Shipper Rail R ate Costs to Fixed C osts Diff. R ate
Package company $1 60 $1 00 $6 0 +$ 30
Grain elevator $190 $100 $90 +$ 30
Power p lant $1 90 $1 00 $9 0 $0
Total $3 80 $2 00 $1 80 +$ 30
4. But at a rate o f $190, the grain elevator too would drop rail
service. W hen it does so, the power plant alone would have to
cover variable costs ($ 100) and all of the railroad’s fixed costs
($ 180). All else being equal, either the power plant pays $280
or the railroad goes out of business. Each shipper is ultim ately
worse off than it w as under standard diffe rentia l pricing.
New Variable Contribution Change From
Shipper Rail R ate Costs to Fixed C osts Diff. R ate
Package company $1 60 $1 00 $6 0 +$ 30
Grain elevator $190 $100 $90 +$ 30
Power p lant $2 80 $1 00 $1 80 +$ 90
Total $2 80 $1 00 $1 80 +$ 90
*An y oth er reg ulatory o r leg islative actio n that arbitrarily forced the railroad to reduce its rate to the p ower plant wo u ld h av e the same effect.