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Modernizing Freight Rail Regulation (2015)

Chapter: 1 Study Background, Charge, and Approach

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Suggested Citation:"1 Study Background, Charge, and Approach." National Academies of Sciences, Engineering, and Medicine. 2015. Modernizing Freight Rail Regulation. Washington, DC: The National Academies Press. doi: 10.17226/21759.
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1

STUDY BACKGROUND, CHARGE, AND APPROACH


The private freight railroad industry in the United States has been the subject of economic regulation by the federal government since the Interstate Commerce Act (ICA) of 1887. With passage of the Staggers Rail Act of 1980, Congress made sweeping changes in this regulatory program. It eliminated or eased many regulations governing rate and service offerings and allowed railroads to redress decades-long declines in traffic, stagnant productivity, and oversized networks that had become chronically under-maintained and misaligned with demand. On the eve of the Staggers Rail Act, the freight railroads were earning too little to reinvest in their networks, and some had already been rescued by government subsidies. By giving railroads more pricing and operating freedom, the act is widely credited with stimulating the industry’s revival to the benefit of shippers and consumers. Significantly, regulations governing railroad–shipper commercial relationships were relaxed and in many cases rescinded. However, deregulation was not complete. The act retained, and in some cases added, regulatory requirements intended to protect rail shippers from loss of service and from excessive rates in markets lacking competitive transportation options. Regulators also retained responsibilities for general oversight of the industry’s financial performance and competitive structure, especially with regard to interactions among railroads.

When Congress last amended the ICA in 1995, it retained all of the deregulatory reforms and most of the regulatory policies and provisions of the Staggers Rail Act while terminating the Interstate Commerce Commission (ICC), the long-standing railroad regulatory agency. The Surface Transportation Board (STB) was created to continue to implement and oversee the residual regulatory program. In the Safe, Accountable, Flexible, Efficient Transportation Equity Act: A Legacy for Users of 2005, Congress called on the U.S. Department

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Suggested Citation:"1 Study Background, Charge, and Approach." National Academies of Sciences, Engineering, and Medicine. 2015. Modernizing Freight Rail Regulation. Washington, DC: The National Academies Press. doi: 10.17226/21759.
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of Transportation (USDOT) to contract with the National Academy of Sciences (NAS) to conduct “a comprehensive study of the Nation’s railroad transportation system since the enactment of the Staggers Rail Act of 1980.”1 Specifically, the 2005 law asks for the NAS study to examine and make recommendations on

  1. The performance of the nation’s major railroads with regard to service levels, service quality, and rates;
  2. The projected demand for freight transportation over the next two decades and the constraints limiting the railroads’ ability to meet that demand;
  3. The effectiveness of public policy in balancing the need for railroads to earn adequate returns with those of shippers for reasonable rates and adequate service; and
  4. The future role of the Surface Transportation Board in regulating railroad rates, service levels, and the railroads’ common carrier obligations, particularly as railroads may become revenue adequate.

This report presents the results of the congressionally requested study, which was conducted by a committee of experts in economics, regulatory policy, and freight transportation. The approach taken by the committee in conducting the study, the emphasis placed on specific elements of the study charge, and the content and organization of the report are explained in this chapter. For context, the chapter begins with an overview of conditions that preceded passage of the Staggers Rail Act and helped shape the current regulatory program. That discussion is followed by an overview of the main elements of the program and its implementation since 1980 by ICC and STB.

HISTORICAL AND POLICY CONTEXT

The Staggers Rail Act was enacted at roughly the same time as laws deregulating the interstate airline, bus, and trucking industries.2 It was

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1 Public Law 109-59, Section 9007.

2 The laws referenced are the Airline Deregulation Act of 1978, the Bus Regulatory Reform Act of 1982, and the Motor Carrier Act of 1980.

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Suggested Citation:"1 Study Background, Charge, and Approach." National Academies of Sciences, Engineering, and Medicine. 2015. Modernizing Freight Rail Regulation. Washington, DC: The National Academies Press. doi: 10.17226/21759.
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passed after a series of enactments during the 1970s had failed to resolve the railroad industry’s deep financial problems.3 Common to all the laws deregulating the transportation industries was the expectation that vigorous competition would bring about a more efficient and responsive supply of service.4 In the airline and interstate trucking industries, most federal regulations restricting pricing, service offerings, and market entry and abandonment were revoked abruptly or phased out over a short time. Six years after passage of the Airline Deregulation Act of 1978, the Civil Aeronautics Board was disbanded and its few remaining authorities to protect consumers and police anticompetitive conduct were transferred to USDOT and the U.S. Department of Justice (USDOJ).5

A notable difference between the Staggers Rail Act and the legislation deregulating the other transportation industries was the former’s stated purpose: to “provide for the restoration, maintenance, and improvement of the physical facilities and financial stability” of the rail transportation system.6 Neither the trucking industry nor the airline industry was in financial distress. Instead, elements of both industries had grown less efficient under regulation, and the industries were seen as unresponsive to the interests of shippers and travelers. Accordingly, their deregulation was focused on unleashing market forces in the hope of making service offerings more innovative and less expensive for consumers rather than spurring industry financial recovery and stability.7 In contrast, the railroad industry’s financial problems were threatening its continued exis

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3 The two major acts preceding the Staggers Rail Act were the Regional Rail Reorganization Act of 1973 (3-R Act) and the Railroad Revitalization and Regulatory Reform Act of 1976 (4-R Act). A review of the history of railroad deregulation is given by Keeler (1983) and by Gallamore and Meyer (2014).

4 A comparative review of the political and economic motivations of deregulation of the transportation industries during the 1970s and early 1980s is given by Derthick and Quirk (1985).

5 The Civil Aeronautics Board Sunset Act of 1984 temporarily transferred merger and acquisition approval to USDOT and then permanently to USDOJ in 1988. To this day, USDOT, rather than the Federal Trade Commission, monitors the airline industry for unfair methods of competition; however, the airline industry is subject to federal antitrust laws as enforced by USDOJ.

6 Public Law 96-448, Section 3, Goals.

7 An expressed goal of the Airline Deregulation Act of 1978 was to bring about an “air transportation system which relies on competitive market forces to determine the quality, variety, and price of airline services” [Public Law 95-504, Section 1-2(a)(9)].

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tence as a private enterprise.8 Two years before the law was passed, the U.S. Secretary of Transportation had warned that “continuation of trends in the postwar period would result within the next 10 years in an industry facing enormous capital shortage, competing only for bulk shipments of low-value goods, lacking the resources necessary for safe operation and, to a very considerable degree, operating under the financial control or ownership of public agencies” (USDOT 1978, 3).

By 1976, the federal government had taken over intercity passenger rail services and consolidated the assets of several bankrupt freight railroads to create Conrail, which would require more than $7 billion in federal subsidies between 1976 and 1981 (CQ Almanac 1982).9 About one-fifth of the industry’s track was operated by bankrupt and bailed-out railroads (GAO 1990, 10), and an estimated 47 percent of freight rail revenues were being earned by railroads that could no longer be considered financially viable (Keeler 1983, 16–17). The bailout of more railroads was viewed as an expensive and controversial proposition in a country devoted to private enterprise. Many of the provisions of the Staggers Rail Act were thus designed to have both the near-term effect of ending the demand for government subsidies and the longer-term effect of bringing financial stability to an industry deemed essential to the economy.

The dire condition of the railroads by the third quarter of the 20th century had been decades in the making. An inflexible and anachronistic regulatory system had contributed substantially, but so too had the advent and expansion of long-haul trucking by siphoning off large amounts of once-profitable high-value freight.10 The two factors were interconnected. Before the reforms introduced by the Staggers Rail Act are described in more detail, an overview of the circumstances preceding and prompting the law’s enactment will be helpful.

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8 Intercity passenger rail service had been nationalized through the creation of the National Railroad Passenger Corporation, which operates Amtrak, in 1971.

9 In addition to spending more than $7 billion to bail out Conrail, ICC had exhausted $275 million in 1979 and 1980 to keep the Rock Island Railroad operating (Gaskins 2008, 563).

10 Gallamore (1999) notes also how railroads were adversely affected by developments such as the decline of industries that were traditional rail customers. The replacement of coal and steel by other materials—such as natural gas, plastics, and aluminum—is an example.

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Antecedents to Deregulation11

The regulatory regime that prevailed in the 1970s had its origins in the 19th century, when railroads and waterways were the predominant modes of long-haul transportation. When Congress passed the ICA in 1887, the 50-year-old railroad industry had been characterized by financial and service instability.12 Often with land grants and sometimes with financial support from state and local governments, scores of private companies had been supplying rail transportation services, each building its own lines and operating trains over them in a vertically integrated manner (Scharfman 1915, 35–38). The instability arose in large part from overbuilding by competing railroads, which was exacerbated by the high capital–labor ratio inherent in railroad technology. Between 1870 and 1890, U.S. railroad track mileage increased by more than 100,000 miles (Scharfman 1915, 33; AAR 2014). Railroads faced considerable difficulty in charging rates sufficient to compensate for their large capital outlays while remaining competitive with one another and with barges and steamships. A railroad could price only up to a customer’s willingness to pay for the service—a willingness that depended heavily on the availability of other transportation options.13

To limit a shipper’s pricing options and prevent destructive “rate wars,” railroads tried to establish cartel pricing agreements among themselves (Scharfman 1915, 19–20, 70–71). These voluntary agreements often broke down, causing intermittent instability in service and prices to the dissatisfaction of both shippers and railroads (Keeler 1983, 22). Provisions in the ICA and its amendments over the next 60 years were designed to encourage pricing agreements and make them more stable—and in turn to make the supply of rail transportation service more reliable for shippers. To do so, the law limited the ability of railroads to enter markets; regulators had to be convinced that entry would

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11 This section provides a brief and somewhat simplified overview of conditions in the railroad industry preceding the Staggers Rail Act’s passage. More in-depth historical reviews are given by Keeler (1983), Gallamore and Meyer (2014), MacAvoy (1965), Kolko (1970), Stone (1991), Conant (1964), Stover (1997), Meyer et al. (1959), and Fogel (1964).

12 For decades before the passage of the ICA of 1887, many states regulated tariffs and routes for both passenger and freight service.

13 Willingness to pay has long been described in the railroad industry as “charging what the market will bear” (Scharfman 1915, 71).

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Suggested Citation:"1 Study Background, Charge, and Approach." National Academies of Sciences, Engineering, and Medicine. 2015. Modernizing Freight Rail Regulation. Washington, DC: The National Academies Press. doi: 10.17226/21759.
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be in the “public convenience and necessity,” including the economic interest of incumbent railroads. Furthermore, the pricing agreements forged among railroads would be structured so that shippers served by multiple railroads would not obtain competing prices. Railroads were regulated as common carriers and thereby required to “serve all who apply,” “provide adequate facilities,” and “refrain from discriminating in rates and service” (Scharfman 1915, 16).

Rather than rates being set according to the willingness of any individual shipper to pay for a railroad’s service, they would be set more uniformly among shippers moving a “like kind of traffic” so that shippers of higher-value goods—who inherently valued the rail transportation service the most—would pay the highest rates regardless of any competitive alternatives enjoyed by some of those shippers (i.e., shippers having multiple rail service options). Such “value of service” pricing was enforced by ICC’s insistence that a railroad granting a rate discount to a shipper with competitive transportation alternatives must also grant the discount to all other shippers not similarly situated (Scharfman 1915, 69–70). Eventually, railroads were able to sustain higher prices through collective agreements using rate bureaus, which Congress made exempt from antitrust scrutiny (Keeler 1983, 27). In return for equalized rates for higher-value shipments, railroads were precluded from raising rates to shippers of lower-value commodities such as coal, corn, and wheat, even in markets where a lack of competitors would have otherwise enabled the exercise of monopoly power (Boyer 1981).

Railroads remained subject to the common law duty to offer “just and reasonable rates” and to respond to all reasonable requests for transportation service without “discrimination” (Scharfman 1915, 191). Rate-setting that discriminated by commodity would be allowed (i.e., value of service pricing), but so-called “local” and “personal” discrimination would not (Scharfman 1915, 119–123). The ICA had prohibited as unjust discrimination any preferential treatment of a “like or contemporaneous service in the transportation of a like kind of traffic under substantially similar circumstances and conditions” (Scharfman 1915, 117). The prohibitions against local and personal discrimination dovetailed with value of service pricing (Keeler 1983, 24). To prevent discrimination among shippers, railroads were precluded from negotiating rate and service contracts with individual shippers unless the

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same terms were extended to all other shippers in similar circumstances for movement of the same goods (Scharfman 1915, 80–85, 117–118). Railroads were further precluded from offering rebates or discounts to shippers of larger volumes and longer hauls. For example, a railroad could not offer a rate that declined on a per carload basis for larger-volume shipments or on a per mile basis for shipments traveling farther (Scharfman 1915, 130). Regardless of demand and supply conditions, railroads were not allowed to adjust the prices they charged for the provision of rail cars. ICC made it difficult for railroads to cancel agreements to interchange traffic with competitors, which limited the ability of railroads to consolidate traffic flows for greater efficiency.

ICC was given authority to approve all railroad plans for line abandonments and service discontinuances. This power enabled regulators to prevent railroads from withdrawing service from shippers of commodities whose regulated rates were kept low and unprofitable. Given the authority to approve and condition mergers, ICC could protect existing traffic divisions among railroads (Crum and Allen 1986, 46–47). Merger approval authority was also seen as a tool that could be used by regulators to preserve the commodity-based system of ratemaking by requiring railroads having a customer base of higher-value (and thus more profitable) commodities to merge with railroads having a customer base of lower-value commodities (Keeler 1983, 24–26).14

This regulatory structure was upset fundamentally by the expansion of public highways and the introduction of tractor-trailer trucks during the early and middle 20th century. Railroads, which lacked the reach and service capabilities of trucks, gradually lost large amounts of their highest-value, nonbulk freight that had been charged the highest rates (Keeler 1983, 28). Concerned that individual railroads would seek to retain this traffic by discounting rates in defiance of the rate bureaus and to the detriment of the profitability of all railroads, ICC regularly stepped in to preserve the cartels and their ability to equalize rates across railroads and shippers (Keeler 1983, 28–29). To limit competition from other modes, Congress broadened ICC’s authority to regulate the rates charged by long-haul trucks. Never-

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14 As Keeler notes, regulators did not use their merger review authority in this manner because of resistance from profitable railroads.

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theless, trucks enjoyed a substantial service advantage over railroads with their more timely and secure door-to-door transport. In view of ICC’s insistence that no individual shipper receive higher service quality or a lower rate than any other shipper in a similar situation, even if such variability was necessary to retain traffic, railroads were bound to lose nearly all of their highest-value business (Gallamore and Meyer 2014, 81–99).

Because of their inability to compete with trucks for high-value freight, railroads were left with a smaller and less diverse traffic base consisting of mostly bulk commodities, whose shippers opposed increases in regulated rates. Meanwhile, railroads had been losing large amounts of their intercity passenger traffic to buses and automobiles, and eventually to airlines.15 Rail networks had become oversized and misaligned with demand. Nevertheless, ICC rate and routing regulations remained in place. Regulators were reluctant to allow railroads to cancel legacy interchange agreements and reduce the scope of their networks (GAO 1987). They made it difficult for railroads to divest lightly used branch lines and to concentrate traffic and capital investments on a smaller number of densely traveled routes (Keeler 1983, 39). In its adherence to both the ICA and the common law doctrine of ensuring that all shippers of the same commodity received similar service at similar rates,16 ICC was slow to grant railroads the ability to charge higher rates for their bulk traffic even in markets where they could have charged a premium because of the absence of effective competition from other railroads and barges. Double-digit inflation during the 1970s compounded these ills, as rate increases lagged growth in railroad costs (Keeler 1983, 32–33).

By the 1970s, several railroads in the Northeast, which had traditionally depended on passenger traffic and short hauls of high-value freight, were bankrupt, including the large Penn Central. The federal government, which was unwilling to let the private railroads stop supplying service altogether, provided hundreds of millions of dollars in loan guarantees

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15 As late as World War I, a majority of train miles were from passenger trains. By the 1920s, ridership was declining. The near disappearance of passenger traffic resulting from automobility left an enormous excess of rail capacity, often in corridors not suited to heavy freight use (Gallamore and Meyer 2014, 100–129).

16 This common law doctrine as it influenced the ICA and ICC’s implementation is described in the following classic texts: Scharfman (1915), Scharfman (1931), Ripley (1912), and Hadley (1885).

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and eventually purchased the assets of the Penn Central and other Northeast railroads to create Conrail in 1976. Faced with the prospect of more bankruptcies and buyouts, Congress then turned to regulatory reform.

Nature of Regulatory Reforms in the Staggers Rail Act

Congress enacted a series of regulatory reforms during the 1970s that culminated in passage of the Staggers Rail Act of 1980. The act introduced several critical reforms aimed at giving railroads greater freedom to price and structure their service offerings and to control their production capacity. It also preserved some old and provided some new protections for shippers, as summarized next.

Freedom to Price According to Each Shipper’s Willingness to Pay

The Staggers Rail Act ended collective pricing through rate bureaus by allowing two or more railroads to set rates jointly only when each is directly involved in the interline movement. The law declared that the new regulatory policy would be to allow “competition and the demand for services to establish reasonable rates for transportation by rail.”17 Regulators were instructed to be aggressive in fully exempting from any further regulatory control all traffic—truck-competitive traffic being the most obvious—for which regulation was “not needed to protect shippers from the abuse of market power.”18 ICC would have no control over the rates charged to shippers of exempt traffic or the amount and quality of service made available to them. For commodities that were not ruled exempt, such as coal, grain, chemicals, and other bulk freight, a critical reform was the law’s legalization of confidential contracts between railroads and shippers. Any shipment moved under contract would be automatically excluded from any further regulation during the life of the contract; railroads would thus be free to tailor their rate and service offerings on a shipper-by-shipper basis.

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17 49 USC §10101 (1).

18 49 USC §10502. Although the exemption provision is not explicit in identifying trucks as the competition of interest, trucks are the only ubiquitous mode, and thus a commodity’s practical capability to be moved by truck became the de facto standard for deciding whether a commodity should be considered inherently competitive and granted a categorical exemption.

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The legalization of confidential contracting was a radical change in regulatory policy. Contracting had not been permitted by ICC because of the aforementioned value of service rate structure and expectations of the uniform treatment of shippers of “like traffic.” The ability of a railroad to contract gave it substantial latitude to set rates differentially according to a shipper’s individual circumstances and willingness to pay, since tariff (i.e., common carrier) rates were no longer generally applicable. The act thus ended ICC prohibitions against “locational” and “personal” rate discrimination as applied to most traffic. Railroads would not only be allowed to compete more aggressively for the newly exempted freight that is inherently competitive with trucks but would also be allowed to set tariff rates for the nonexempt bulk commodities at levels equivalent to the most rail-dependent shipper’s willingness to pay. While shippers with more transportation options would be expected to refuse to pay the higher rate, a railroad could simply negotiate a discounted contract rate with terms tailored to each shipper’s specific situation and willingness to pay. The price-differentiating railroad would now be able to set rates at levels that avoid pricing any profitable traffic flows out of the market.19 If successful, the deregulated railroads could earn the revenues needed to keep supplying rail service over the long term and perhaps earn even more.

Freedom of Operations and Capacity Utilization

The Staggers Rail Act contained provisions that would help the financially distressed railroads restructure their oversized and misaligned networks. For example, the act modified ICC’s long-standing authority to approve line abandonments and mergers. In the case of abandonments, the law eased the approval process by establishing a time limit for approvals and allowing railroads to present evidence on whether the line was earning the cost of capital. To facilitate mergers, the law established time limits for decisions and continued to exempt the industry from conventional antitrust review by USDOJ according to the Clayton Act’s sole criterion that competition not be substantially lessened to the

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19 Because of the incentive to extract rents but not price traffic out of the market, the efficiency loss from railroads having pricing freedom is expected to be minimal. Indeed, limited deadweight loss was found by Grimm and Winston (2000, 65).

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detriment of consumers. ICC would continue to review mergers under a broader “public interest” standard that required an evaluation of competition effects but that gave regulators more discretion to consider other factors. Among such factors were the merger’s ability to reduce duplicative, uneconomic legacy capacity and its effect on the financial health of railroads that would be competing with the newly merged railroad.

To allocate their rail cars more efficiently, railroads were given the freedom to adjust rates for the delivery of cars according to fluctuations in demand—for example, by charging a premium for grain cars when demand for grain exports was high. Because they were no longer subject to rate restrictions that precluded rebates and discounts, railroads could offer pricing incentives for shippers to tender larger, consolidated shipments and to concentrate traffic on main lines. The Staggers Rail Act had the practical effect of ending open routing. Railroads were allowed to cancel many legacy joint rate, terminal access, trackage rights, and reciprocal switching agreements affecting traffic they could otherwise transport directly (GAO 1987). On these routes they would no longer be required to offer a common carrier rate for partial moves to transfer points.20 ICC was instructed not to interfere with the cancellation of these legacy agreements, and it was only authorized to order agreements if the intervention was deemed to be in the public interest or “necessary to provide competitive rail service.”21 However, neither criterion was well defined in the law, nor was ICC obligated to exercise the authority, and for the most part it did not.

Assurance of Reasonable Rates in Markets Lacking Effective Competition

The aforementioned freedom to set rates was limited by a single requirement, applicable to common carrier service only, for “reasonable rates where there is an absence of effective competition and where rail rates

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20 Railroads had never been required to quote a rate for a partial move that they could otherwise serve fully. The Staggers Rail Act did not change this practice despite its other provisions giving railroads more market power. Nevertheless, over the years ICC had imposed conditions on mergers that required railroads to maintain access agreements for traffic that could otherwise be served directly. The act made cancellation of these agreements easier for railroads (GAO 1987).

21 49 USC §11102.

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provide revenues which exceed the amount necessary to maintain the rail system and to attract capital.”22 Although railroads would have substantial leeway to set their rates, regulators were tasked with ensuring that common carrier rates remained “reasonable” in cases in which a shipper could demonstrate that a railroad lacked effective competition and when the rate surpassed a specified threshold. That threshold, defined in the law as 180 percent of “variable cost,” could be viewed as an attempt to provide railroads with a safe harbor for pricing their traffic at levels high enough to contribute to capital costs while providing a trigger for regulators to scrutinize unusually high rates. This regulatory backstop could also provide shippers with some downward pressure on rates and leverage in negotiating contracts in markets lacking effective competition.

Preservation of the Obligation to Provide Common Carrier Service

Before the regulatory reforms that commenced in the 1970s, all rail service was provided by common carriage, and thus all regulations concerning common carriage had general applicability. By effectively requiring that truck-competitive traffic be exempted from regulation, the Staggers Rail Act removed the common carrier obligation for a large amount of traffic. The legalization of contracting further reduced the share of traffic in common carriage and left ICC with the authority to establish and enforce the rules governing the obligation’s fulfillment for a declining slice of traffic. However, the law provided no clear avenue for regulators to prescribe and enforce definitive standards of service quality. Inasmuch as common carrier rates would be allowed to change and become more heterogeneous, so too would common carrier service attributes. Regulators, who were limited in their ability to influence service except by establishing rules for the disclosure and dissemination of tariff terms, would, in essence, become a sounding board for service-related concerns expressed by shippers. Regulators would be able to respond to these concerns only indirectly by using regulatory authorities governing rail car availability, train operations, and the reporting of relevant data.

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22 49 USC §11102.

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Assurance of the Opportunity for Railroads to Earn Adequate Revenues

Enacted when many railroads were not earning their cost of capital, the Staggers Rail Act emphasized that railroads should not be denied the opportunity to become revenue adequate and indeed required that regulators seek to promote this outcome. Revenue adequacy as an explicit goal of regulatory policy originated in the 4-R Act of 1976,23 which directed ICC “to make an adequate and continuing effort to assist [railroads] in attaining such revenue levels” as needed to “provide a flow of net income plus depreciation adequate to support prudent capital outlays, assure the repayment of a reasonable level of debt, permit the raising of needed equity capital, and cover the effects of inflation.”24 In passing the Staggers Rail Act 4 years later, Congress elevated revenue adequacy to one of the chief policies of the revised regulatory program. In addition to keeping the 4-R Act’s requirement that ICC assist railroads in attracting and retaining capital, the act directed ICC to “maintain, and revise as necessary, standards and procedures” to “annually determine which rail carriers are earning adequate revenues.”25

The provision requiring annual revenue adequacy determinations resides in the section of the law governing the adjudication of rate reasonableness disputes. Therefore, its inclusion could be viewed as indicating a congressional interest in eventually using the revenue adequacy results to inform regulatory decisions about rate reasonableness when a railroad is earning revenues that substantially exceed its cost of capital. Any intentions along those lines (i.e., to use the revenue adequacy measures to define a monopoly profit constraint) remain controversial, but a clearer purpose—given the concern over the financial viability of railroads when the Staggers Rail Act was passed—was to guide affirmative measures to revive the distressed railroads while ensuring that any further regulatory interventions did not risk that revival.26

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23 Public Law 94-210.

24 49 USC §15(a)(4).

25 49 USC §10704.

26 For a discussion of the history of the law’s requirement for revenue adequacy determination, see Macher et al. (2014).

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Implementation of Staggers Rail Act Reforms

Although implementation of a number of the reforms in the Staggers Rail Act led to legal and rulemaking challenges, many were adopted fairly quickly. Confidential contracting became legal immediately and thus automatically began to exclude growing amounts of traffic from direct regulatory control. In response to the law’s stipulations to minimize regulatory controls and to grant regulatory exemptions to the “maximum extent,” ICC quickly exempted entire categories of commodities and car types from regulation, including shipments moved in boxcars and intermodal containers. The agency also expedited railroad requests to sell and abandon lightly used lines. Many merger requests were approved by ICC according to the law’s broad public interest standard that allowed for merging private railroads to offset any adverse competition effects with estimates of the profitability from reducing perceived duplicative capacity. A wave of mergers ensued after passage of the act, which contributed to a decline in the number of Class I railroads from 41 in 1979 to 16 by 1987, as reported by the Association of American Railroads [AAR; various years (1980, 1987)].27

A major implementation challenge facing ICC was the law’s new requirement of maintaining reasonable rates for common carriage in markets lacking effective competition. To comply, ICC would need to develop a new system to estimate the “variable cost” of shipments. The purpose was to compare such costs with rates to determine a shipper’s eligibility to challenge a rate. Furthermore, regulators would need to institute procedures for confirming that a market lacks effective competition and for assessing whether a disputed rate is unreasonable. By the end of the 1980s, ICC had instituted procedures for all three elements of the law’s rate relief provision: (a) a revamped cost allocation system that purported to estimate a variable cost for each priced traffic movement, (b) evidentiary procedures for adjudicating claims of market dominance, and (c) an evidentiary standard for judging the reasonableness of a disputed rate. The standard required a complainant

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27 One of the causes of the reduction in Class I railroads was the periodic adjustment of Class I regulatory definitions and declassifications by ICC. Class I railroads are identified on the basis of total revenues. The threshold changes when STB updates for inflation. The revenue threshold in 2013 was $467 million.

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shipper (or group of shippers) to establish the minimum revenue a railroad would need to serve the traffic at issue in a “stand-alone” manner.

In a series of rulings on the law’s provisions giving railroads more operating and pricing freedom, ICC reaffirmed and clarified that a railroad would not be required to offer a local common carrier rate to an intermediate point for a freight movement that it could serve fully on its own.28 A railroad could thus be the sole server of traffic originating or terminating only on its lines. It could prevent access to competing connecting service and thereby increase its market power and its exploitation of that power by pricing traffic according to each shipper’s willingness to pay. Furthermore, ICC ruled that the authority to order a railroad to allow a competing railroad access to its sole-served traffic through reciprocal switching and other access arrangements would only be invoked to preclude or remedy a service abuse arising from anticompetitive conduct. The authority to order such access arrangements would not be used in a more generalized manner to inject competition into markets to reduce rates. ICC maintained that the Staggers Rail Act does not prohibit railroads from obtaining and exercising market power, as evidenced by the statutory formula that allows pricing up to 180 percent of variable cost. ICC also pointed out that the act’s maximum rate provisions already gave aggrieved shippers an outlet for contesting excessive rates.

Finally, in compliance with the requirement to issue annual determinations of railroad revenue adequacy, ICC developed procedures for calculating the industrywide average cost of capital. Each Class I railroad’s finances would be examined annually, and any railroad whose average return on investment equaled or surpassed the industrywide cost of capital would be ruled revenue adequate.

Rapid Turnaround and Transformation of the Railroad Industry

Passage of the Staggers Rail Act paid early dividends. If ending government subsidies had been a main impetus for the law, success was

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28 In making this ruling, known as the “bottleneck” decision, ICC referred to a long-standing history in railroad rate regulation that the reasonableness of a rate is to be assessed on a “through” basis to preclude requirements that a railroad quote tariff rates for partial routings when it was capable of providing the full routing on its own. The bottleneck issue is discussed in more detail in Chapter 4.

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almost immediate; Conrail did not require federal funds after 1981, and no federal subsidies were granted to other railroads. Conrail was privatized in 1987, and its assets were sold to Norfolk Southern and CSX 11 years later.

With regard to the economic performance of the industry as a whole, almost every measure indicates that the law’s reforms helped trigger a turnaround. Trends in some basic industry statistics reveal the scope and pace of change in productivity, efficiency, and innovation after the Staggers Rail Act was passed in 1980 (Table 1-1). A comparison of 1970 with 1995—spanning the low point of the bankruptcy of the Penn Central to the creation of STB—indicates that the major railroads shed more than 40 percent of their track mileage, two-thirds of their employees, and nearly one-third of their locomotives. As Table 1-1 shows, most of these capacity reductions occurred after 1979 during the post-Staggers years, when railroad traffic (in ton-miles) increased by 44 percent. By 1995, Class I railroads had learned to make much more intensive use of their inputs and assets: ton-miles per track mile tripled, ton-miles per carload nearly doubled, and tons per train grew by nearly 60 percent compared with 1970. Thus, the track that remained was used more intensely, and greater emphasis was placed on investing in more powerful locomotives. More efficient and cost-conscious railroads thus increased their output per employee and output per gallon of fuel consumed by 400 and 74 percent, respectively. Again, most of these productivity gains occurred after 1979.

The Class I railroads became specialists in the long-distance movement of freight, as the average length of a haul increased by nearly two-thirds from 1970 to 1995. Many shippers located along thousands of miles of lightly used branch lines divested by the major railroads were served by hundreds of regional and short-line railroads, many of which commenced operations after passage of the Staggers Rail Act.29 By the mid-1990s, more than 400 of these railroads, most of which connect with and feed traffic to the major railroads, operated more than 40,000 miles of divested track. Although they were still specialists in

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29 Regional railroads, as defined by AAR, are line-haul railroads operating at least 350 miles. Short-line railroads are line-haul railroads that operate smaller networks or that primarily perform switching. Some are jointly owned by two railroads for the purpose of transferring cars at interchanges and in shared terminal facilities.

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TABLE 1-1 Selected Statistics for Class I Freight Railroads, 1970–2013

Statistic 1970 1979 1995 2005 2013 Percent Change
1970–1995 1979–1995 1995–2013
Real revenue ($ millions) (2013 dollars) 51,161 62,702 44,430 51,570 70,514 −13 −29 59
Ton-miles (millions) 764,809 904,956 1,305,688 1,696,425 1,740,687 71 44 33
Miles of track owned 319,092 277,242 180,419 164,291 161,980 −43 −35 −10
Employees (approximate) 566,000 475,000 188,000 162,000 163,000 −67 −60 −13
Locomotives 27,077 28,097 18,812 22,779 25,033 −31 −33 33
Gallons of fuel used (millions) 3,545 4,080 3,480 4,192 3,682 −2 −15 6
Real revenue per ton-mile (cents) (2013 dollars) 6.7 6.9 3.4 3.0 4.1 −49 −51 19
Ton-miles per fuel gallon 216 222 375 414 473 74 69 26
Ton-miles per employee 1.4 2.0 7.0 10.5 10.7 400 250 53
Ton-miles (millions) per track mile 2.4 3.3 7.2 10.3 10.8 202 119 48
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Ton-miles per carload 28,311 39,199 55,032 54,473 60,377 94 40 10
Tons per trainload 1,820 2,096 2,870 3,115 3,488 58 37 22
Average miles per ton hauled 515 616 842 894 990 63 37 18
Real capital expenditures ($ millions) (2013 dollars) 6,328 8,716 8,493 7,413 13,091 34 −3 54
Capital expenditures as a percentage of revenue 12.4 13.9 19.1 14.4 18.6 34 38 −3
Percent of freight revenue lost or damaged 1.97 1.10 0.33 0.22 0.12 −83 −70 −64
Train accidents per million train miles NA 11.4 4.1 4.1 2.4 NA −64 −42
Intermodal containers or trailers 2,363,200 3,278,163 7,936,172 11,693,512 12,831,692 236 142 62

NOTE: NA = not available.

SOURCE: AAR various years (1980–2014). Rate, revenue, and expenditure figures are in real terms, adjusted for inflation by using the U.S. Bureau of Economic Analysis gross domestic product chained price deflator.

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bulk transportation, the Class I railroads adapted to play a major role in the intermodal container revolution caused by the large increase in international trade. Rail deregulation did not create the demand for this container traffic, but it enabled railroads to respond more effectively through innovative service offerings such as by double-stacking containers on unit trains and by partnering with steamship lines to provide transcontinental connections (“land bridges”) between the nation’s container seaports and interior hubs. With their freedom to contract with shippers, railroads were able to reclaim a role in the movement of high-value goods. They eventually partnered with rival trucking companies for the line-haul segment of long-distance container and semitrailer movements (Gallamore and Meyer 2014, 285). By 1995, railroads were transporting more than three times as many containers and semitrailers as they had 25 years earlier (Table 1-1).

The statistics suggest that shippers benefited substantially from the productivity improvements of the deregulated railroads. Despite the 44 percent increase in ton-miles from 1979 to 1995, inflation-adjusted (real) freight revenues fell by nearly 30 percent. Although the average revenue per ton-mile (RPTM) was clearly affected by fundamental changes in traffic composition (e.g., an increase in intermodal shipments and average length of hauls), the magnitude of the rate reductions—down about 50 percent from 1979 to 1995—suggests that most rail shippers benefited from substantially reduced prices. A number of other statistics in Table 1-1 suggest favorable developments for rail shippers, such as reductions in freight losses and damages, but their direct connection to deregulation is less certain because rail safety and security trends had been improving through the 1970s. Although railroad capital expenditures declined slightly in real terms between 1979 and 1995, expenditure levels grew in relation to freight revenue and to the leaner railroad system overall.

The early effects of the Staggers Rail Act on productivity, rates, and service quality have been studied by economists. Results from studies comparing rate levels from the prederegulation and early deregulation periods are summarized by Ellig (2002, 154) in Table 1-2. They indicate that the large cost savings and productivity gains that followed regulatory reform were passed on to shippers through lower rates. Many of the cited studies were conducted only a few years after passage of

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TABLE 1-2 Rail Rates Studies, Early Postderegulation Period

Authors and Year of Publication Period Studied Measure Studied Response to Staggers Rail Act Reforms
R. L. Banks and Associates, Inc., and Fieldston Company (1998) 1981–1996 Real RPTM 21 percent lower after controlling for other factors
Wilson (1994) 1981, 1988 Rates for 34 commodities 1981: some rates higher, some lower, some unchanged
1988: all rates lower or unchanged
Burton (1993) 1973–1987 Rates for 17 major commodities 1985 rates lower by 3 to 34 percent, depending on commodity
Average rates 10 percent higher in 1981; 30 percent lower in 1988
Barnekov and Kleit (1990) 1970–1987 Average rates 16 to 19 percent lower in 1987, saving shippers $6 billion to $8.5 billion (1998 dollars)
Winston et al. (1990) 1985 Rates and service time, all commoditiesa Rate changes altered shipper welfare by minus $3 billion to plus $1.5 billion; shippers were $4.4 billion to $11.4 billion better off due to better service (1998 dollars)
McFarland (1989) 1969–1987 Average rates Unchanged
MacDonald (1989) 1981–1985 Wheat rates Fell 18.5 percent from 1981 to 1985
Corn rates Fell 9 percent in 1982, rose 2 percent in 1983, fell 20 percent in 1985
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Authors and Year of Publication Period Studied Measure Studied Response to Staggers Rail Act Reforms
Lee and Baumel (1987) 1971–1984 Average rates Accelerated rate reductions by 5 percentage points
Boyer (1987) 1970–1985 Average rates Statistically insignificant evidence of 2 percent rate increase
Grimm and Smith (1987) 1984 Rates for all National Industrial Transportation League members 50 percent had lower rates, 12 percent had higher rates, and 38 percent were unchanged
Sorenson (1984) 1977–1983 Kansas grain rates to Gulf of Mexico for export Fell 43 percent from 1981 to 1983
Kansas grain rates to Kansas City Fell 32 percent from 1981 to 1983

aRates and service changes for each commodity were weighted to reflect shipper’s probability of using rail for the shipment. Savings figures are the combined effect of the Staggers Rail Act and the Motor Carrier Act of 1980, which deregulated trucking.

SOURCE: Ellig 2002, 154.

the Staggers Rail Act, but they are generally consistent in finding that even shippers who experienced rate increases at the outset were likely to experience real rate declines of 10 to 25 percent by the start of the 1990s, when the effects of the law’s reforms had taken hold. For the most part (as discussed in more detail later), economic studies from the period point primarily to the industry’s productivity gains, along with price competition with trucks, as the main drivers of lower rates, and secondarily to the effects of parallel and end-to-end railroad mergers in reducing uneconomic railroad capacity and improving operating efficiencies.

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Measuring changes in productivity and rates is easier than measuring changes in railroad service characteristics (such as transit time, reliability, and cargo loss and damage), but evidence of the Staggers Rail Act reforms having an early, positive effect on service quality had been reported in the literature. Grimm and Smith (1987), for example, reviewed responses to an industry association survey of shippers. They found that 30 percent reported improvements in service speed, reliability, and rail car availability, whereas two-thirds reported no change and 10 percent reported service degradation. After reviewing the few early postderegulation studies (Winston 1998; Barnekov and Kleit 1990; Winston et al. 1990) that placed monetary values on changed service, such as the effects of faster delivery and greater service reliability on lowering inventory costs, Ellig (2002, 159) concluded that savings to shippers from improved service were of the same order of magnitude as the savings from reductions in rates.

PERSISTENT CONCERNS AND REGULATORY CHALLENGES

By 2005, the railroad industry had clearly turned the corner. In the 25 years since passage of the Staggers Rail Act, ton-miles had increased by nearly 90 percent; track miles and employees had declined by 41 and 63 percent, respectively; and average RPTM had fallen by 60 percent in real terms (Table 1-1). Productivity continued to improve according to a number of measures, including ton-miles per employee, fuel consumed, and mile of track. However, after 2000, railroads began adding locomotives and employees to meet growing freight demand, since fewer opportunities for concentrating traffic in existing capacity or for expanding car sizes and making longer trains remained. The seven Class I railroads30 left from the 41 that operated in 1979 had shed most of their legacy uneconomic capacity and become adept at operating and pricing in a deregulated environment that favored tighter

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30 The seven Class I railroads in order of revenue are BNSF Railway Company, Union Pacific Railroad Company, CSX Transportation, Grand Trunk Corporation (Canadian National’s U.S. operations), Kansas City Southern Railroad Company, Norfolk Southern Railway, and Soo Line Corporation (Canadian Pacific’s U.S. operations). They accounted for 94 percent of railroad industry revenues in 2013.

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levels of capacity than the regulated railroads had long been required to maintain.31

During the early 2000s, rates had begun to rise, first in nominal and then in real terms partway through the decade (rate trend data are shown in Chapter 2). Between 2002 and 2007, real rates increased by more than 15 percent. The increases were noticed by shippers, who had grown accustomed to a secular decline in rates over the previous two decades. Service disruptions had occurred after the merger of the Union Pacific and the Southern Pacific Railroads in 1996, and more episodic service disturbances had been experienced during 2004.32 Shippers expressed concern that consolidation of the railroad industry and efforts to rationalize capacity were contributing to the rising rates and perceived increases in the frequency and duration of service disruptions.

In response to growing congressional concern about the causes of these service disturbances and the changing direction in railroad rates (GAO 2006), in 2007 STB sponsored a comprehensive study of post-Staggers economic and competitive conditions in the railroad industry. The study was completed by Laurits R. Christensen Associates in 2009 and 2010.33 It took a longer-term view spanning the 1980s to 2008 and confirmed many of the positive findings from the postderegulation economic studies cited earlier. However, the overall performance of the railroad industry in the wake of regulatory reform was of less immediate interest to policy makers than was an understanding of the causes of the changes that had been taking place after 2000. Christensen Associates found that rail rates in general had been rising after about 2002, although largely in accordance with rising fuel prices and slowing gains in railroad productivity. The

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31 Gallamore (1999) and Gaskins (2008) give firsthand accounts of the difficulties that some railroads had in adapting to the new environment at the outset of deregulation and of how the adaptations were eventually made.

32 In 2004, during a period of rapid growth in container and other rail freight traffic, the Southern California seaports experienced severe congestion, which was attributed to lack of rail capacity for transportation of arriving containers as well as to port capacity constraints. However, rail shippers complained of degraded service in other regions during the same period (CBO 2005, 1–3; Lavigne 2014).

33 The multivolume report can be found at http://www.stb.dot.gov/stb/elibrary/CompetitionStudy.html.

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study documented the success of the railroads in reducing the industry’s excess, uneconomic capacity and in increasing its capabilities with regard to differential pricing (i.e., pricing to what the market would bear).

The upward trend in rates during the early 2000s accentuated concerns that had persisted since enactment of the Staggers Rail Act—that “captive” shippers (rail-dependent shippers served by only one railroad) would be adversely affected by the law’s deregulatory provisions intended to allow railroads to obtain and exercise more market power. A decade earlier, when Congress had terminated ICC, implementation of the Staggers Rail Act’s many deregulatory provisions (e.g., commodity exemptions, legalization of confidential contracts, abandonment approvals) had been largely complete. A primary role of the successor STB would be to administer the residual regulatory program, a key component of which was the protections afforded to captive shippers from unusually high common carrier rates and unresponsive service. However, even during the 1980s and early 1990s, shippers were not satisfied with all aspects of ICC’s implementation of the Staggers Rail Act. A number of concerns that were first raised during ICC’s implementation of the act became magnified for STB as rates began to rise after 2000 and railroads began to exhibit increased profitability. A synopsis of these concerns is provided next, because they are central to the study’s review of STB’s implementation of the current regulatory program.

Competitive Effects of Industry Consolidation and Capacity Reductions

Some shippers expressed concerns that ICC had placed too much emphasis on helping railroads achieve financial stability by cutting capacity and too little on protecting shippers from competition losses that risked higher rates and less reliable service.34 They maintained that regulators had been too permissive in approving

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34 See, for example, Western Coal Traffic League comments to the Union Pacific–Southern Pacific merger hearings, STB FD No. 32670, March 29, 1996. Also see the statement of Thomas D. Crowley on behalf of the Western Coal Traffic League before the House Committee on Transportation and Infrastructure, Hearing on the Condition of the Railroad Industry, April 22, 1998.

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mergers and acquisitions. The principal purpose was to eliminate financially weak railroads and raise the traffic and revenues of the financially stronger railroads that remained. In creating STB, Congress retained ICC’s authority to approve mergers despite calls by shippers to transfer the authority to the Antitrust Division of USDOJ. In completing a review begun under ICC, STB approved the 1996 merger of the Union Pacific and Southern Pacific Railroads over the objections of some shippers and USDOJ.35 Severe service disruptions that ensued after the merger were a factor in prompting STB to suspend further merger applications in 2000 and to revise its merger appraisal procedures. The revised procedures placed less emphasis on improving the financial health of railroads and more on preserving sufficient levels of competition, as had been advised by USDOJ. After the moratorium, merger applications involving Class I railroads ceased; nevertheless, shippers complained that many opportunities to preserve beneficial competition and levels of capacity had been lost over the previous two decades.36

Access to Rate Relief Procedures

Rail shippers also raised concerns about the cost and complexity of evidentiary standards intended to detect unreasonably high rates in markets that lacked effective competition.37 The development of these standards proved particularly challenging for ICC as it sought to respect the law’s interest in the attainment of revenue adequacy by railroads. Regulators had tried to provide a consistent standard for assessing the reasonableness of rates that took into account a railroad’s earning requirements to attract capital. The stand-alone cost (SAC) standard was designed to determine the cost of supplying rail service in a given set of corridors in a stand-alone manner (i.e., largely outside the context of the railroad’s broader network and traffic

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35 See testimony of Steven C. Sunshine, Deputy Assistant Attorney General, Antitrust Division, statement before U.S. House of Representatives Committee on Transportation and Infrastructure, January 26, 1995. http://www.justice.gov/atr/public/testimony/0056.htm.

36 See shipper comments to STB Ex Parte No. 582-1, Public Views on Major Rail Consolidations, and specifically comments by the National Industrial Transportation League, November 17, 2000.

37 A summary of shipper concerns about rate relief access is given by GAO (1999).

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base). It proved to be time-consuming and complicated to adjudicate almost immediately and required several million dollars in litigation expenses per case (GAO 1999, 45–49). The SAC procedure was originally instituted with shippers of large and regular traffic volumes in mind, particularly shippers of coal transported in a single corridor.38 Coal shippers raised concerns about the high cost of litigating a SAC case and results that often produced a conservatively high assessment of the revenue-adequate rate. However, resolution of a single coal case held the potential for tens of millions of dollars in overcharge penalties and future transportation savings from a lower prescribed rate (GAO 1999, 46). The ability of coal shippers to use the SAC standard at least held out the possibility that the law’s rate relief protections would deter high coal rates and provide coal shippers with greater leverage when contracts were negotiated.

The SAC standard had limited applicability to shippers who shipped in small quantities or on an irregular basis. Hence, when a decade had passed and only a few shippers of commodities other than coal had filed a rate case, pressure mounted for ICC to introduce alternative evidentiary procedures that promised broader access to the law’s maximum rate protections. In particular, shippers of smaller volumes and shippers who used more varied routes argued that the lack of rate cases was indicative not of a shortage of grievances but of an evidentiary standard that was inappropriate for their circumstances and that entailed minimum litigation costs that exceeded their smaller claims. When it created STB in the ICC Termination Act of 1995, Congress ordered the new agency to develop expedited procedures for resolving disputes that could be used by more shippers who were unable to use the SAC standard.39

In response to the congressional directive, STB retained the SAC procedure but added two new simplified procedures with lower evidentiary standards and limits on monetary awards. STB also restricted the types of evidence that railroads could introduce to refute claims that a market is dominated, which had been adding to the cost and complexity of rate cases. However, even as it sought to broaden access

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38Coal Rate Guidelines, Nationwide. 1985 [1 ICC.2d 520, 1985 WL 56819 (ICC)].

39 49 §10701(d)101.

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to the rate relief process, STB remained committed to structuring its new rate review procedures so that they remained focused on comparing rates with estimates of the revenue needs of the railroad in providing the service. Like ICC before it, STB was reluctant to introduce rate relief procedures that risked conflicting with the law’s interest in ensuring railroad revenue adequacy.

Over the past decade, a number of rate relief cases have been filed by shippers of chemicals, as well as coal, under the expedited procedures for assessing market dominance and reasonable rates.40 Railroads have expressed concern that restrictions placed on the evidence allowed in market dominance inquiries have led to exaggerated findings of market power, particularly by failing to account for a shipper’s ability to discipline rates by shipping to other markets and by changing its production levels and locations.41 Overall, however, shippers of many commodities that move predominantly by common carriage, including bulk grain and other farm products, have not used the simplified procedures. These shippers maintain that the caps on awards were too low to justify the expense of bringing a case, the standards (including a simplified version of SAC) remain inappropriate to their circumstances, and the decision criteria for an unreasonable rate ruling remain unclear.42

Evidence of Railroad Revenue Adequacy

Like ICC, STB is required to make annual determinations of each Class I railroad’s revenue adequacy. For most of its first 10 years, STB determined that all railroads were falling short of revenue adequacy according to its industrywide average cost of capital measure.43 Railroads viewed these findings as indicative of a continued need to limit regulatory intervention and particularly to proceed cautiously in changing the standards used for adjudicating rate protests. Meanwhile, shippers

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40http://www.stb.dot.gov/stb/industry/Rate_Cases.htm.

41 STB Ex Parte No. 717.

42 See shipper comments to STB Ex Parte No. 665-1, Rail Transportation of Grain, Rate Regulation Review. In particular, see comments by the National Grain and Feed Association, p. 14, June 26, 2014.

43 See STB Ex Parte No. 552-1 through 10.

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have claimed that the method used to judge revenue adequacy does not reflect the reality of railroads having obvious access to credit markets and have identified other indicators of railroad profitability such as positive balance sheets and rising stock values.

Having long been critical of STB’s annual findings of most railroads falling short of revenue adequacy, some shippers now commend the results as more railroads have been declared revenue adequate during the past 5 years.44 In response, shipper groups have asked STB to reexamine how it uses the revenue adequacy results. They contend that the new findings of railroad profitability are relevant to the law’s stated policy “to maintain reasonable rates where there is an absence of effective competition and where rail rates provide revenues which exceed the amount necessary to maintain the rail system and to attract capital.”45 Some would like to see STB expand access to rate relief by taking a less cautious approach to safeguarding railroad revenue adequacy and profits.46 Railroads contend that because they are capital intensive, the concern over sustaining revenue adequacy and the profit incentive that encourages capacity investments must remain at the forefront of regulatory policy. They argue that using an industrywide cost-of-capital measure to assess rate relief is tantamount to a profitability test that would be impractical to administer and contradict the law’s policy of minimizing federal regulatory control.47

Common Carrier Service Expectations

Shipper complaints of railroads violating their common carrier duties by not complying with reasonable requests for service date back to the beginning of the U.S. railroad industry (Scharfman 1915).

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44 See comments submitted jointly by the American Chemistry Council, the Fertilizer Institute, the Chlorine Institute, and the National Industrial Transportation League to STB Ex Parte No. 664-2, September 5, 2014, pp. 5–6.

45 See comments submitted jointly by the American Chemistry Council, the Fertilizer Institute, the Chlorine Institute, and the National Industrial Transportation League to STB Ex Parte No. 664-2, September 5, 2014, pp. 5–6.

46 See comments to STB Ex Parte No. 722 by the Arkansas Electric Cooperative Corporation, the Western Coal Traffic League, Consumers United for Rail Equity, the Olin Corporation, and other shippers and shipper groups.

47 See AAR comments to STB Ex Parte No. 722, November 4, 2014.

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Since the Staggers Rail Act split the industry into common and contract carriage, shippers who rely on the former have been vocal in expressing their concerns about inferior treatment. For example, they allege that railroads are prone to making costly demands for infrastructure improvements as a condition for service, withholding tariff rates until the potential for contract negotiations is exhausted, and refusing to quote tariff rates from locations offering less profitable traffic volumes.48 Shippers also maintain that railroads favor their contract customers to the exclusion of fulfilling their common carrier obligations. In particular, grain shippers contend that railroads give preferential treatment in the allocation of locomotives, crews, and rail cars to their contract customers to the detriment of shippers who have few options other than common carriage by rail.

In responding to such complaints, railroads maintain that the common carrier duty is not well defined and should not be interpreted to mean that capacity must be made readily available to meet all requests for transportation service, particularly when the demand for service can be irregular and unpredictable.49 They also raise concerns of their own, including the requirement of serving all kinds of traffic under the common carrier obligation, particularly the obligation to transport shipments that pose toxic inhalation hazards such as tank car loads of chlorine and anhydrous ammonia. Railroads would like to see such shipments made exempt from standard terms of common carriage to allow negotiation of compensatory rates and the addition of legal protections from potentially ruinous liability.50

Petitions for Competitive Access

When railroads began canceling their legacy terminal access, trackage rights, and reciprocal switching arrangements as permitted by the Staggers Rail Act, many shippers complained that their rail transporta-

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48 Allegations can be found in the large number of comments submitted to STB Ex Parte No. 677. The examples given here are drawn from statements by the National Grain and Feed Association, April 27, 2008, and the Western Coal Traffic League, April 17, 2008.

49 See AAR filings to STB Ex Parte No. 677 and No. 677-1.

50 See comments of AAR to STB Ex Parte Nos. 677 (March 2008) and 677-1 (July 2, 2008).

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tion options were being sharply curtailed (GAO 1987). Shippers petitioned ICC to stop the cancellations and to order railroads to reestablish the arrangements to prevent railroads from obtaining too much market power. Like ICC, STB has insisted that its authorities to order such access arrangements were not intended for general use as a measure to inject competition into markets but rather as a targeted tool to remedy specific instances of competitive abuse. Shippers have persisted in their objection to this policy. At the time of this study, STB was considering a petition from a shipper group to establish a new policy that would lead to mandatory reciprocal switching agreements in markets where a shipper is served by only one railroad and an interchange with another railroad is located within 30 miles.51

STUDY CHARGE AND APPROACH

With these concerns and regulatory challenges as a backdrop, Congress called for this study of the federal railroad regulatory program and its implementation by STB. The study’s full statement of task appears in Box 1-1. The main charge consists of the four tasks requested by Congress in the 2005 law (the Safe, Accountable, Flexible, Efficient Transportation Equity Act: A Legacy for Users) calling for the study. The four are followed by six additional queries that were added by the study sponsors, the Federal Railroad Administration and USDOT. The committee concentrated its efforts on the charge given to it by Congress, but responses to the six additional queries are presented in Appendix A.

The fourth task asks for policy recommendations with regard to the future role of STB. The committee decided to approach the first three tasks in a manner that would help inform its recommendations about the regulatory program’s future. Therefore, the committee did not conduct a historical review of railroad rate, service, and capacity changes since the 1980 Staggers Rail Act reforms. Instead, it focused on recent trends and developments that are more pertinent to the modern freight railroad industry that has emerged in the three decades since regulatory reform. Under this approach, the committee saw no reason to

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51 STB Ex Parte No. 711, National Industrial Transportation League Petition, March 30, 2013.

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Box 1-1

STUDY STATEMENT OF TASK

The study shall address and make recommendations on the

  1. Performance of the nation’s major railroads in the post–Staggers Act era with regard to service levels, service quality, and rates;
  2. Projected demand for freight transportation over the next two decades and the constraints limiting the railroads’ ability to meet that demand;
  3. Effectiveness of public policy in balancing the need for railroads to earn adequate returns with those of shippers for reasonable rates and adequate service; and
  4. Future role of the STB in regulating railroad rates, service levels, and the railroads’ common carrier obligations, particularly as railroads may become revenue adequate.

As part of the analysis undertaken to address the four areas above stipulated by Congress, the committee shall, to the extent possible based upon existing data and prior analyses,

  1. Examine rates and service levels by type of shipper and commodity, service lane, shipper size, and shipper type;
  2. Estimate whether railroad exercise of market power has increased since deregulation and the impact this has had on rates and/or service;
  3. Describe the potential role that freight rail can serve in shifting some future growth in highway freight shipments to rail;
  4. Comment on the role freight rail can serve in meeting the Department of Transportation’s strategic goals;
  5. Assess whether Class I freight railroads are earning their cost of capital; and
  6. Assess whether railroads continue to be a decreasing cost industry due to economies of density or whether average and marginal costs are rising and the implications the latter has for STB oversight and regulation.
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examine deregulatory provisions of the Staggers Rail Act that were fully implemented years ago, such as the granting of regulatory exemptions to commodities and the legalization of private contracting. The study concentrates on a limited set of regulatory provisions that STB continues to administer and that remain controversial and candidates for updating and change.

Although it examines and offers advice on specific regulatory provisions in the Staggers Rail Act, the committee refrained from critiquing the act’s overarching policy goals. They were taken as given. Because these policies are referenced frequently in the report, they are shown in Box 1-2. Among them are the law’s interest in assuring reasonable rates and the ability of railroads to achieve revenue adequacy. The committee assumes that policy makers remain satisfied with these overarching policy goals; the focus of the study therefore was on finding ways to make the regulatory program more effective in achieving them.

In asking the committee for recommendations on the future role of STB in furthering these policies, Congress added the following phrase: “particularly as railroads may become revenue adequate.” The committee interprets this phrase to indicate an interest in a study of the regulatory program in the context of a changing, postderegulation freight railroad industry. For reasons explained in this report, the committee believes that mechanistic regulatory appraisals of a railroad’s revenue adequacy can offer little, if any, insight for policy making. Nevertheless, it is evident that financial conditions in the freight railroad industry are fundamentally improved over the dire circumstances that prevailed in the 1970s and that prompted the regulatory reforms of the Staggers Rail Act. Similarly, the transition period following deregulation, and the uncertainty that it held, has long passed. Yet 35 years after passage of the Staggers Act, many features of the program that were shaped by these earlier circumstances persist.

As they reviewed the existing regulatory program, committee members were struck by its attachment to concerns that have faded (and in some cases expired) and to the preservation of regulatory techniques that were a staple of the pre-Staggers ICC. The annual pass/fail appraisal of each railroad’s revenue adequacy and reliance on traffic costing schemes known to be invalid for decades are examples of features of STB’s program that are anachronistic

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Box 1-2

U.S. FREIGHT RAILROAD REGULATORY POLICY

In regulating the railroad industry, it is the policy of the United States Government to

  1. Allow, to the maximum extent possible, competition and the demand for services to establish reasonable rates for transportation by rail;
  2. Minimize the need for Federal regulatory control over the rail transportation system and to require fair and expeditious regulatory decisions when regulation is required;
  3. Promote a safe and efficient rail transportation system by allowing rail carriers to earn adequate revenues, as determined by the Board;
  4. Ensure the development and continuation of a sound rail transportation system with effective competition among rail carriers and with other modes, to meet the needs of the public and the national defense;
  5. Foster sound economic conditions in transportation and to ensure effective competition and coordination between rail carriers and other modes;
  6. Maintain reasonable rates where there is an absence of effective competition and where rail rates provide revenues which exceed the amount necessary to maintain the rail system and to attract capital;
  7. Reduce regulatory barriers to entry into and exit from the industry;
  8. Operate transportation facilities and equipment without detriment to the public health and safety;
  9. Encourage honest and efficient management of railroads;
  10. Require rail carriers, to the maximum extent practicable, to rely on individual rate increases, and to limit the use of increases of general applicability;
  11. Encourage fair wages and safe and suitable working conditions in the railroad industry;
  12. Prohibit predatory pricing and practices, to avoid undue concentrations of market power, and to prohibit unlawful discrimination;
  13. Ensure the availability of accurate cost information in regulatory proceedings, while minimizing the burden on rail carriers of developing and maintaining the capability of providing such information;
  14. Encourage and promote energy conservation; and
  15. Provide for the expeditious handling and resolution of all proceedings required or permitted to be brought under this part.

SOURCE: 49 USC §10101: Rail transportation policy.

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and lack an economic foundation. Therefore, a question that arose repeatedly during the committee’s discussions and that guided its review was how to bring the post-Staggers regulatory program into the modern age.

CONTENT AND ORGANIZATION OF REPORT

The remainder of this report is organized as follows.

Chapter 2 addresses the elements of the first two tasks of the study charge by examining (a) recent trends and patterns in railroad rates, (b) concerns expressed by rail shippers about freight rail service levels and quality, and (c) projections of demand for rail freight and associated concerns about long-range capacity constraints and possibly capacity shortages.

The analysis of railroad rates was aided by access to STB’s annual Carload Waybill Sample (CWS), particularly the confidential version that contains actual rates paid by shippers using contract as well as common carriage. The traffic and revenue data in the CWS, which is designed to be a representative sample of shipment waybills, were analyzed for 2000 to 2013, a period considered to be reflective of industry circumstances today and relevant for current policy assessment.

The CWS data are used to review rate trends and patterns at an industrywide level, by commodity group, and for shipments moved in both common and contract carriage. Data on trends in railroad input costs and productivity levels help in understanding general patterns in rates observed over the past decade. A better explanation would have required more extensive evaluations and knowledge of demand and supply conditions at the commodity- and market-specific levels. Therefore, the rate analyses in the chapter are presented mainly as background and do not factor directly into the study’s conclusions and recommendations pertaining to the regulatory program. Nevertheless, a particularly relevant observation from the CWS concerns the disparities among commodity groups in their use of common carriage. This observation was significant in informing the committee’s assessment of the adequacies of the law’s rate relief provisions, which apply only to common carrier traffic.

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With regard to railroad service levels and quality, the discussion in Chapter 2 is largely descriptive. It summarizes concerns raised by shippers claiming to have experienced more frequent and lengthy service disruptions and inferior service quality generally in their use of common carriage. Whereas some quantitative data on railroad service performance are available, they are insufficient in detail and completeness to characterize the overall direction of service quality or its variability among traffic segments. Better information would have been helpful to the committee in fulfilling the study charge to review service performance. More significantly, better information is essential for regulators in ensuring that the common carrier service obligation is being met.

The complaint data indicate that shipper concerns about common carrier rates and service performance tend to increase during periods when railroads must redeploy capacity quickly to accommodate abrupt changes in demand or adapt to other exogenous conditions such as severe winter weather. Shippers often associate service problems with insufficient allocation of or investment by railroads in rail cars and physical infrastructure, including the capacity needed to handle demand surges. Thus, Chapter 2 concludes with a general discussion of the incentives of the private railroads to deploy and invest in capacity to serve shippers. The committee was specifically asked to examine the projected demand for freight transportation over the next two decades and the constraints that may limit the railroads’ ability to meet that demand. Consideration is given to recent freight forecasts and to whether the projections of long-term rail capacity shortages that are based on them are sound.

In response to the third task in the study charge, Chapters 3 and 4 examine the design and implementation of certain provisions in the Staggers Rail Act. The provisions are intended to guarantee that shippers have access to common carrier service at a reasonable price and with adequate quality. The law’s other policy interests, such as ensuring that railroads have the ability to earn adequate returns, are taken into account.

Chapter 3 examines the law’s maximum rate protections and their implementation by STB. The agency’s Uniform Railroad Costing System, qualitative assessments of market dominance, and the SAC test and other cost-based methods for granting rate relief are key to the

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implementation. The chapter examines each in turn. Having found a number of methodological deficiencies, the committee then considers the feasibility of introducing an alternative approach for identifying unusually high rates that does not rely on regulatory costing methodologies. On the basis of data from actual shipment rates and characteristics from the CWS, the committee shows that prediction of the rates that would be charged for shipments in effectively competitive markets is practical. The predicted, or benchmark, competitive rates can be used by shippers of similar shipments in noncompetitive markets to determine whether their rates are unusually high. In a sense, this procedure implements the common law notion that “like” traffic under substantially similar circumstances should not have to pay substantially different rates. A specific benchmarking model is demonstrated more fully for illustrative purposes in Appendix B.

Chapter 4 examines four additional features of the railroad regulatory program: (a) the common carrier service obligation, (b) the requirement to make annual determinations of each Class I railroad’s revenue adequacy, (c) the exemption of railroad mergers from standard antitrust reviews in favor of a public interest appraisal by STB, and (d) the regulatory authority to order reciprocal switching as necessary to provide competitive rail service.

As currently defined and practiced, the common carrier service obligation is a throwback to another era. The obligation is not accompanied by uniform service quality standards and is difficult to enforce in the absence of relevant information on service quality at the shipment-specific level. A review of the obligation indicates how these data deficiencies will need to be addressed if the common carrier obligation is to remain relevant. The critiques of the annual railroad revenue adequacy appraisal by STB and the long-standing application of a public interest standard for reviewing railroad mergers raise fundamental questions about the continued relevance of these regulatory practices, especially in light of the railroad industry’s financial turnaround. In the case of STB’s authority to order reciprocal switching, the review questions why the agency continues to refrain from exercising this authority as a remedy for unreasonable rates.

Chapter 5 summarizes the report’s background and context sections and the findings from the review of rate trends, service quality issues,

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and long-term capacity constraints. The findings from the review of STB regulatory provisions and practices are discussed in detail. The committee, which was asked to advise on the agency’s future role, draws on these findings to make a series of recommendations intended to address deficiencies in the current regulatory program and make it reflective of circumstances in the industry today, 35 years after passage of the Staggers Rail Act.

REFERENCES

Abbreviations
AAR Association of American Railroads
CBO Congressional Budget Office
GAO General Accounting Office or Government Accountability Office
USDOT U.S. Department of Transportation

AAR. 2014. A Short History of U.S. Freight Railroads. April. https://www.aar.org/BackgroundPapers/A%20Short%20History%20of%20US%20Freight%20Railroads.pdf.

AAR. Various years. Railroad Facts. Washington, D.C.

Barnekov, C. C., and A. N. Kleit. 1990. The Efficiency Effects of Railroad Deregulation in the United States. International Journal of Transport Economics, Vol. 17, No. 1, pp. 21–36.

Boyer, K. D. 1981. Equalizing Discrimination and Cartel Pricing in Transport Rate Regulation. Journal of Political Economy, Vol. 89, No. 2, pp. 270–287.

Boyer, K. D. 1987. The Cost of Price Regulation: Lessons from Railroad Deregulation. Rand Journal of Economics, Vol. 18, pp. 408–416.

Burton, M. L. 1993. Railroad Deregulation, Carrier Behavior, and Shipper Response: A Disaggregated Analysis. Journal of Regulatory Economics, Vol. 5, No. 4, pp. 417–434.

CBO. 2005. Freight Rail Transportation: A Review of the 2004 Experience. Washington, D.C.

Conant, M. 1964. Railroad Mergers and Abandonments. University of California Press, Berkeley.

CQ Almanac, 37th ed. 1982. Congress Grants Conrail a Reprieve, pp. 561–564. http://library.cqpress.com/cqalmanac/cqal81-1171745.

Crum, M., and B. Allen. 1986. U.S. Transportation Merger Policy: Evolution, Current Status, and Antitrust Considerations. International Journal of Transport Economics, Vol. 13, No. 1, pp. 41–75.

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Derthick, M., and P. Quirk. 1985. The Politics of Deregulation. Brookings Institution, Washington, D.C.

Ellig, J. 2002. Railroad Deregulation and Consumer Welfare. Journal of Regulatory Economics, Vol. 21, No. 2, pp. 143–167.

Fogel, R. W. 1964. Railroads and American Economic Growth: Essays in Economic History. Johns Hopkins University Press, Baltimore, Md.

Gallamore, R. 1999. Regulation and Innovation: Lessons from the American Railroad Industry. In Essays in Transportation Economics and Policy: A Handbook in Honor of John R. Meyer (J. Gómez-Ibáñez, W. Tye, and C. Winston, eds.), Brookings Institution Press, Washington, D.C., pp. 493–529.

Gallamore, R., and J. Meyer. 2014. American Railroads: Decline and Renaissance in the Twentieth Century. Harvard University Press, Cambridge, Mass.

GAO. 1987. Competitive Access and Its Effects on Selected Railroads and Shippers. RCED 87-109.

GAO. 1990. Railroad Regulation: Economic and Financial Impacts of the Staggers Rail Act of 1980. RCED 80-90.

GAO. 1999. Railroad Rate Relief Process. RCED 99-46.

GAO. 2006. Freight Railroads: Industry Health Has Improved but Concerns About Competition and Capacity Should Be Addressed. RCED 07-94.

Gaskins, D. W. 2008. Regulation of Freight Railroads in the Modern Era: 1970–2010. Review of Network Economics, Vol. 7, No. 4, Dec., pp. 561–572.

Grimm, C. M., and K. G. Smith. 1987. The Impact of Rail Regulatory Reform on Rates, Service Quality, and Management Performance: A Shipper Perspective. Logistics and Transportation Review, Vol. 22, pp. 57–68.

Grimm, C., and C. Winston. 2000. Competition in the Deregulated Railroad Industry: Sources, Effects, and Policy Issues. In Deregulation in Network Industries: What’s Next? (S. Peltzman and C. Winston, eds.), American Enterprise Institute–Brookings Joint Center for Regulatory Studies, Washington, D.C., pp. 41–71.

Hadley, A. T. 1885. Railroad Transportation: Its History and Laws. G. P. Putnam’s Sons, New York.

Keeler, T. 1983. Railroads, Freight, and Public Policy. Brookings Institution, Washington, D.C.

Kolko, G. 1970. Railroads and Regulation, 1877–1916. Princeton University Press, Princeton, N.J.

Lavigne, G. 2014. Port of Long Beach Says Congestion Has Been Worse. JOC.com, Oct. 23.

Lee, T., and C. P. Baumel. 1987. The Cost Structure of the U.S. Railroad Industry Under Deregulation. Journal of the Transportation Research Forum, Vol. 28, No. 1, pp. 245–253.

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MacAvoy, P. 1965. The Economic Effects of Regulation: The Trunk-Line Railroad Cartels and the Interstate Commerce Commission Before 1900. Massachusetts Institute of Technology Press, Cambridge.

MacDonald, J. M. 1989. Railroad Deregulation, Innovation, and Competition: Effects of the Staggers Act on Grain Transportation. Journal of Law and Economics, Vol. 32, pp. 63–96.

Macher, J. T., J. W. Mayo, and L. F. Pinkowitz. 2014. Revenue Adequacy: The Good, the Bad and the Ugly. Center for Business and Public Policy, Georgetown University, Washington, D.C.

McFarland, H. 1989. The Effects of United States Railroad Deregulation on Shippers, Labor, and Capital. Journal of Regulatory Economics, Vol. 1, pp. 259–270.

Meyer, J. R., M. J. Peck, J. Stenason, and C. Zwick. 1959. The Economics of Competition in the Transportation Industries. Harvard University Press, Cambridge, Mass.

R. L. Banks and Associates, Inc., and Fieldston Company, Inc. 1998. Rail Freight Rates in the Post-Staggers Era.

Ripley, W. Z. 1912. Railroads: Rates and Regulation. Longmans, Green and Company, New York.

Scharfman, I. L. 1915. Railroad Regulation: An Analysis of the Underlying Problems in Railroad Economics from the Standpoint of Government Regulation. LaSalle Extension University, Chicago, Ill.

Scharfman, I. L. 1931. The Interstate Commerce Commission. Commonwealth Fund, New York.

Sorenson, L. O. 1984. Some Impacts of Rail Regulatory Changes on Grain Industries. American Journal of Agricultural Economics, Vol. 66, No. 5, Dec., pp. 645–650.

Stone, R. 1991. The Interstate Commerce Commission and the Railroad Industry: A History of Regulatory Policy. Praeger, New York.

Stover, J. 1997. American Railroads, 2nd ed. University of Chicago Press, Chicago, Ill.

USDOT. 1978. A Prospectus for Change in the Freight Railroad Industry: A Preliminary Report by the Secretary of Transportation. Office of the Secretary.

Wilson, W. W. 1994. Market-Specific Effects of Rail Deregulation. Journal of Industrial Economics, Vol. 42, No. 1, pp. 1–22.

Winston, C. 1998. U.S. Industry Adjustment to Economic Deregulation. Journal of Economic Perspectives, Vol. 12, No. 3, pp. 89–110.

Winston, C., T. M. Corsi, C. M. Grimm, and C. A. Evans. 1990. The Economic Effects of Surface Freight Deregulation. Brookings Institution, Washington, D.C.

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Next: 2 Recent Rate Trends and Service and Capacity Issues »
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TRB Special Report 318: Modernizing Freight Rail Regulation examines the future role of the Surface Transportation Board (STB) in overseeing and regulating the service levels and rate offerings of railroads, particularly as they become revenue adequate. The approaches recommended in this congressionally-requested report are intended to resynchronize a regulatory program that has become outdated.

The study committee finds that while the U.S. freight railroad industry has become modernized and financially stable since the Staggers Rail Act of 1980, some of the industry’s remaining economic regulations have not kept pace and should be replaced with practices better-suited for today’s modern freight rail system.

Specifically, the study committee finds that more appropriate, reliable, and usable procedures are needed for resolving rate disputes. It recommends that Congress prepare for the repeal of the current formula for screening rates for eligibility for rate relief, and direct the U.S. Department of Transportation to develop a more reliable screening tool that compares disputed rates to those charged in competitive rail markets. This tool would replace current methods that make artificial and arbitrary estimates of the cost of rail shipping.

Current adjudication methods can cost millions of dollars for litigation and some have taken years to resolve, deterring shippers with smaller claims from seeking rate relief. Simplified methods that are economically valid and practical to use have yet to be introduced. The study committee recommends that STB hearings used to rule on the reasonableness of challenged rates be replaced with arbitration hearings that compel faster, more economical resolutions of rate cases. It also recommends that arbitrators be empowered to use reciprocal switching as a remedy for those rates found to be unreasonable.

The study committee recommends the transfer of merger review authority to antitrust agencies. It also recommends that STB give priority to the data needed to oversee the railroads’ response to their common carrier service obligation by collecting and analyzing shipment-level data on service quality.

Press Release

Two page summary of the report

Recording of Surface Transportation Board Roundtable Discussion, October 25, 2016:

Recording of Richard Schalensee's Testimony at Surface Transportation Board Hearing, June 10, 2016:

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