Rail Deregulation in the United States

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Author: Dr. Brian Slack

1. Introduction

Rail deregulation in the United States is a good example of how a policy shift can produce significant changes in the economic health of an industry, and how its structure may be changed. In the United States the rail industry has since its inception been operated by the private sector. However, because of their importance, their fixedness as well as their monopoly in several regions, the rail industry became early the object of public scrutiny and political intervention. The railroads began to be seen to operate the service in the public interest, and therefore have been bound by certain government regulations. The policies that developed over the first 100 years of rail operations were intended to prevent a monopoly and to maintain open access.

A regulatory board established in 1887, the Interstate Commerce Commission (ICC), grew in power to control freight rates, oversee mergers and acquisitions, and regulate competition between the modes by preventing ownership in different modes. The problem with the railroads was that they were losing market share by the middle of the 20th Century. The automobile replaced a lot of short-haul passenger business, and airlines were beginning to take away passengers on the long-haul market which used to be dominated by rail. Freight traffic began to suffer because of competition from trucking. The result was that whereas in the 1920 the railroads accounted for 75% of all intercity freight movements, by 1975 this share fell to 35%. The ICC had set rates deliberately low for farm products and higher rates for general freight, which was the most susceptible to truck competition. At the same time the railroad industry had little incentive to modernize because the ICC had to rule on major changes, and the railroads found it difficult to obtain approval to close unprofitable track and services. The railway industry was therefore operating in a highly constrained environment leaving limited opportunities for innovation.

2. Deregulation

The need to reform the industry was made necessary because of its imminent collapse. By 1960 one third of the US rail industry was bankrupt or close to failure. This forced policy makers to act. However, the willingness to undertake regulatory reform was enhanced by the conclusions of several academic studies. Economists demonstrated that the regulatory boards had been ‘captured’ by the industry itself, with members being drawn largely from the transport companies themselves. At the same time the accepted theories concerning the threat of monopoly control over prices were being challenged by a new theory of contestability. This theory held that a monopolist would be prevented from charging monopoly prices if there was a threat that other firms could enter the industry. The threat of entry would be sufficient to discourage the monopolist from abusing his market position. The key question was freeing entry levels. In many regulated industries, the regulators restricted entry. Thus, the conditions for policy change were thrust on legislators, and there was a growing acceptance for a solution based on a relaxation of regulatory control.

The first round of policy change was the Railroad Revitalization and Regulatory Reform Act of 1976 (sometimes referred to as the 4R Act) which eased regulations on rates, line abandonment, and mergers. Four years later, when the political tide of deregulation was in full spate, Congress followed up with the Staggers Rail Act of 1980. The most important features of the Staggers Act were the granting of greater pricing freedom, streamlining merger timetables, expediting the line abandonment process, allowing multi-modal ownership, and permitting confidential contracts with shippers.

3. Consequences

The railroads immediately divested themselves of their unprofitable passenger business, and began to concentrate on their core freight activity, the business which was most profitable and least subject to competition from other modes was bulk freight. Rail traffic became increasing dominated by flows of coal, grain, and ores, indeed 43% of all traffic was accounted for by coal shipments in 2003. Larger capacity cars were brought into service. Although general freight produced higher revenues per ton it was more subject to competition, and therefore received less attention.

Railroads face high fixed costs, being the only mode that has to build and maintain its own tracks. The high cost of maintaining unprofitable routes was a major drain on resources. Thus, in the post-Staggers Act environment, the railroads began abandoning tracks. Over 100,000 miles of track have been abandoned as operators increasingly focused on strategic long distance corridors linking major gateways and inland markets.

Operating costs were reduced significantly by staff reductions. Contracts with the unions produced agreement to remove the brakemen from trains, thereby doing away with one third of the personnel required for train operation and removing the need for cabooses. Other concessions, such as hours of work and daily distances crews are allowed operate, have significantly improved productivity.

With the release of regulatory control over rates, the railroads could begin charging market rates, and because they were allowed to enter into confidential contracts they had greater flexibility in negotiating with large volume shippers. This introduced more competition between the modes and led to lower rates overall.

Because there was a relaxation in controls over entry and exit, the post deregulation period has been marked by a significant development in mergers and acquisitions. From 56 Class I railroads in 1975 the number has been reduced to 7 in 2005, two of which are Canadian. This has generally helped the industry achieve scale economies that has boosted their economic performance. The North American rail landscape is thus characterized by large regional markets.

Finally, the restrictions on intermodal ownership and operation has led to a revitalization of the general freight business with alliances with trucking companies to carry their long distance cargo. For the first time, intermodal traffic accounted for the majority of rail revenues in 2003.

Consumers have benefited by lower rates, the railroads have achieved much higher levels of performance, and traffic has increased. By 2003 the market share of rail for intercity freight shipments was 42%, against 35% in 1975. Although revenues have not grown at the pace of these other parameters, the US railroad industry has made a profit since deregulation, and seemingly has been rescued from bankruptcy.