GOVERNMENT REGULATION OF THE RAILROADS

The railroads engaged in a variety of discriminatory pricing policies that while understandable and sometimes justifiable from an economic point of view, nevertheless stirred considerable opposition from customers who felt victimized by discrimination. One of the most irritating forms of discrimination was the difference in long-haul and shorthaul rates. Before 1870, each railroad usually had some degree of monopoly power within its operating area. However, as the railway network grew, adding more than 40,000 miles in the 1870s and 70,000 miles in the 1880s, the trunk lines of the East and even the transcontinentals of the West began to suffer the sting of competition. To be sure, major companies often faced no competition at all in local traffic and therefore had great flexibility in setting prices for relatively short hauls, but for long hauls between major cities,

Public land granted to the railroads as a subsidy and in turn sold to settlers was a continuing source of capital funds. Ads like this one appeared in city newspapers, luring thousands of Americans and immigrants westward. Note that each region of the state is carefully described so that farmers can buy land suitable for crops with which they have some experience.

There were usually two or more competing carriers. The consequence was a variance in the rates per mile charged between short and long hauls. The shipper paying the short-haul rate was understandably embittered by the knowledge that similar goods traveling in the same cars over the same track were paying a lower rate.

There were other forms of discrimination. Railroad managers were in charge of firms with high fixed costs, so they tried to set rates in ways that would ensure the fullest possible use of plant and equipment. Where it was possible to separate markets, managers set rates in a discriminating way. For example, rates per ton were set much lower on bulk freight such as coal and ore than on manufactured goods. If traffic was predominantly in one direction, shipments on the return route could be made at much lower rates because receiving any revenue was better than receiving nothing for hauling empty cars. For shippers, this common problem is called the “backhaul problem.” Another form of rate discrimination arose when the same railroad was in a monopolistic position with respect to certain customers (a producer of farm machinery in the Midwest, for example) and a competitive position with respect to others (a favorably located producer of coal who could turn to water transport). Shippers not favored by these discriminatory rates or by outright rebates were naturally indignant at the special treatment accorded to their competitors. Railroads also discriminated among cities and towns, a practice especially resented by farmers and merchants of one locality who watched those in another area enjoy lower rates for the same service.

There is a possible economic justification for these practices: By discriminating among customers, the railroad may have been able to increase its total output and lowered costs. Indeed, if forced to charge one price to all, a railroad may not have been able to cover its costs and remain in business. But the person paying the higher price generally didn’t see things that way, and the pressure to regulate discriminatory practices grew rapidly (Economic Reasoning Proposition 2, choices impose costs).

Opposition to the railroads was heightened by the trend toward price fixing. By 1873, the industry was plagued by tremendous excess capacity. One line could obtain business by cutting rates on through traffic, but only at the expense of another company, which then found its own capacity in excess. Rate wars during the depressed years of the 1870s led to efforts to stop “ruinous competition” (as railroad owners and managers saw it). Railroads responded by banding together on through-traffic rates. They allocated shares of the business among the competing lines, working out alliances between competing and connecting railroads within a region. More often than not, though, these turned out to be fragile agreements that broke under the pressure of high fixed costs and excess capacity. To hide the rate cutting, shippers might pay the published tariff and receive a secret rebate from the railroad. Sooner or later, word of the rebating would leak out, with a consequent return to open rate warfare.

To provide a stronger basis for maintaining prices, Albert Fink took the lead in forming regional federations to pool either traffic or profits. The first was the Southern Railway and Steamship Association, which was formed in 1875 with Fink as its commissioner. Then, in 1879, the trunk lines formed the Eastern Trunk Line Association. But the federations eventually came unglued as weak railroads or companies run by aggressive managers or owners such as Jay Gould broke with the pool and began price cutting (Chandler 1965, 161). Shippers and the general public naturally resented pooling as well as price discrimination. The result was widespread support for government regulation of the railroads.