45-855 Railroads, The First Big Business: Topic 10
Railroads and the Dead Hand of the Government
State Regulation of Railroads
Under the English Common Law all businesses were public by definition,
and all came within the jurisdiction of the legislature. Legislatures had the
power to set prices and to regulate business under their police power. Price
fixing persisted for many callings well into the 19th Century. For
example, innkeepers, tavern keepers, bakers, millers, carriers (porters, couchmen, etc.)
had their maximum fees/rates fixed in law.
Early American canal, bridge, and turnpike companies received corporate
charters. Because these were intended as monopolies and cheapness was one of the
intended attributes, the legislature set the maximum toll which was uniform in
distance. Hence, no discrimination against persons or places. Anyone could use
the "highway" by paying the toll according to the distance used. A shipper would then
pay the toll and a fee to the carrier (wagon, barge, etc.) for services
However, railroads were very different. The peculiarities of railroad
transportation were such that the railroad had to own
both the highway and
the carriers using the highway! This fact plus the high fixed costs of
railroads inevitably lead to discrimination against
persons, places, and types of traffic.
The high fixed costs of railroads and the pricing system they
produced, inevitably led to efforts to regulate railroad passenger and freight
rates by the States.
State politicians soon discovered that uniform or
freight charges were impractical. Capitalists and entrepreneurs simply moved
to another state with more rational regulation. It was recognized quite early
that discrimination against types of traffic
Discrimination against places was a difficult problem to solve. As the
oyster example shows, what is "fair" here is not easily determined. Most state
regulatory schemes tried to address the problem with some form of the
haul pricing constraint (SHPC). For example,
if A, B, C, and D are cities in
that order along a railroad line then the rate from A to B, Rab must
not exceed the rate from A to D; that is, Rab £
For example, in the state of Iowa prior to the railroads, the
Mississippi river towns were the primary shipping points for farmers' grains.
The grains would be loaded on steamboats and sent down to New Orleans for export.
With the arrival of the railroads -- the first railroad bridge across the
Mississippi was built at Rock Island in 1856 -- the farmers could ship their
grain to Chicago and from Chicago it could go to the Atlantic coast via either lake steamer or one
of the trunk lines. In the fierce competition for business, it was often the case
that the railroad rate from the Iowa interior to Chicago was lower than the
rate from the interior to one of the Mississippi river towns! Hence the push on
the part of the river town business people for railroad rate regulation within
the state of Iowa.
These freight rate discriminations were one of the key reasons for
the dislike of the railroads and the visible railroad leaders such as
By 1876 most states had passed laws regulating rates inside their
borders (intrastate rates). Many of these laws were patterned after the Massachusetts law which
set up a quasi-judicial commission to adjudicate disputes between shippers and
Munn vs. Illinois
In 1877 the Supreme Court upheld the right of the states to regulate
Chief Justice Waite used the old 17th Century custom in English
jurisprudence that accepted the regulation of a business clothed with a public
"When Private Property is devoted to public use, it is subject to
public regulation." For example, a privately owned
One of the dissenters, Justice Stephen J. Field, argued that the
regulation of railroad rates was in effect confiscation of private property.
The railroads were being deprived of property without due process of law in
violation of the 5th and 14th Amendments. This argument
later became known as
substantive due process.
Wabash, St. Louis, and Pacific Railroad
In 1886 the Supreme Court in effect reversed the
and struck down an Illinois law regulating railroad rates.
The Court argued that State railroad regulation violated the interstate
commerce clause of the Constitution. Only Congress could regulate interstate
In a companion case,
Santa Clara County vs. Southern Pacific
Railroad, the Court defined the SPRR as a legal person!
Hence, the 5th and 14th Amendments were
The Interstate Commerce Act of 1887
All this turmoil led to the passage of the ICA in 1887.
The Act outlawed rebates, drawbacks, and pooling. It required the
railroads to post the rates in every depot and station and required the rates
to be "reasonable and just".
The Act contained a
Short Haul Pricing Constraint.
Finally, the act set up a Commission to adjudicate disputes between
shippers and the railroads. The ICC was the first federal government regulatory
Social Costs -- Best guess is that the ratio of losses to gains was
about 2 to 1. Short haul freight rates fell about 15 to 30 percent while long
haul freight rates rose. Because about 2/3 of the traffic was long haul freight,
the losses of the long haul shippers were much greater than the gains of the
short haul shippers.
The ICA was vaguely written and did not have the independent means
to enforce its determinations.
The actions of the ICC could be appealed to the federal courts and it
took about 4 years to settle any particular point of dispute.
During the first 10 years 90% of the ICC's rulings on rate charges
were reversed in federal court. Consequently, the number of shipper appeals
The Reconstruction of the Railroad System: 1900-1915
During the tremendous expansion of the economy after 1896 the railroad
system in the U.S. was almost totally rebuilt in order to keep up with the demands
on the system.
Between 1900 and 1915 railroad mileage increased from 259,000 to
391,000 miles and the number of locomotives increased from 36,000 to 66,000.
Heavier steel rails were laid down and most important routes were double and
quadruple tracked. Locomotives became bigger and heavier as did the hopper and
freight cars. Steel bridges replaced older wooden ones and enormous stations
were constructed in almost every major American city.
The productivity gains were impressive up to about 1910. After 1910
the strict government regulation removed the railroads' ability to control their
prices. The railroads had been plowing enormous capital back into their systems
so that improvements kept up with traffic demands. Afer 1910 the railroads were
increasingly squeezed by higher and higher labor costs, an ever increasing demand
for their services, but no ability to raise prices in response.
"Progressives" believed that freight rates should not be so high so
as to generate a surplus for the railroads. If there was a surplus, then the
railroads should lower their rates so as to give the surplus back to the "people".
It was the responsibility of investors to expand the physical plant. After the
investors were paid their dividend, any surplus should go back to the "people".
The "Progressives" did not understand the idea that a "surplus" could be reinvested
in the company! This forced many railroad leaders like James J. Hill to hide
their surpluses in the costs side of their ledgers in order to have the capital
necessary to improve their roads.
Investment by American Railroads (From
Enterprise Denied, by Albro Martin
Elkins Act of 1903
Partly in response to pressure from the railroads, Congress made
it illegal to ask for a rebate.
In the original ICA, railroads
could be punished for giving a rebate but if shippers asked for one,
that was not a criminal act.
Hepburn Act of 1906
Authorized the ICC to set maximum rates and to order railroads to
comply after 30 days.
Set up a system of fast appeals in the Federal
Instructed the courts to accept ICC rulings until evidence was
massed to the contrary. In effect,
railroads were guilty until
Mann-Elkins Act 1910
Federal courts removed from the process. The ICC was empowered to
suspend proposed rate increases.
Railroads were forbidden from acquiring competing lines.
Jurisdiction of ICC expanded to telephone, telegraph, cable, and
The Adamson Act of 1916 (the 8-Hour Day) -- Mandated the 8 hour day on
the railroads as of 1 January 1917. This substantially increased the labor costs
of the railroads. No rate increase was granted by the ICC to make up for the
Average Railroad Operating Ratio
Most of the major railroads were bankrupt by 1917. Almost no rate
increases were granted by the ICC between 1907 and 1917. The railroads applied
for rate increases in 1911, 1913, 1914, and 1917, and were only granted some
very minor increases in 1914. At the same time, labor costs
increased steadily through this period. With no control over their prices, rising
labor costs, and an explosion in demand, the railroads increasingly went into
debt in order to finance the necessary upgrades to their systems. When the
government nationalized the railroads in 1917 they were mostly bankrupt. Finally,
but too late, the railroads were granted a rate increase in 1918 equal to what they
had asked for over the previous 7 years. But, by 1919, it was too late for the
railroads. Capital flowed into the automotive, radio, and electrical industries
and it was too late to integrate the motor freight lines into the
From: "Changes in Industry and the State of Knowledge as Determinants of
Industrial Invention," by Jacob Schmookler. In
The Rate and Direction of
Transportation Act of 1920
To make up for some of the damage, Congress instructed the ICC to
set minimum rates. This was intended to make certain that the
railroads had an adequate income.
The ICC was granted more authority over entry, exit, and consolidation of
the railroad industry.
Setting minimum rates backfired because the emerging trucking
industry was able skim off much of the high value short haul freight