Railroad Problems of the Immediate Future

I.

THE EXISTING SITUATION.

THE Interstate Commerce Law aimed to secure equality of treatment between different shippers in place of the system of preferences which had prevailed up to that time. Different persons were to be treated exactly alike; different places, different commodities, or different quantities of the same commodity were to be treated differently only so far as a difference of circumstances and conditions actually warranted it. The law did not try to prescribe rates, — it left this power in the hands of the railroad agents; it simply forbade the railroads to reduce rates for one shipper without extending the same privileges to others.

It is four years since the law went into operation ; not time enough, perhaps, to test its merits, but time enough to disappoint the extravagant hopes which were at first entertained in some quarters. The act is far from being a solution of the problem of railroad control. It is but a single step in that direction. Some men are dissatisfied with the means provided for securing the objects of the law. Others regard those objects themselves as weak and unsatisfactory. Those who believed that the law would put an end to the agitation which preceded it, or would leave us more settled than we were before, have already seen their mistake. So far from being the end, it is but the beginning.

The American railroad system has grown up under the theory that it was a business to be managed by the investors, rather than a public agency to be run by the State. The theory has been that the public interest would be better served by allowing railroads to go where business demanded them and charge what they could get, than by letting the legislature decide which railroads were wanted and how much they should charge. The Interstate Commerce Law involved no radical departure from this theory. Except for the clause prohibiting pools, which was foreign to the general drift and tenor of the act, it aimed only to check specific abuses, leaving the general methods of management untouched. The Interstate Commerce Commission has been at times disposed to go a little farther than this ; the state authorities have gone a great deal farther; while the expressions of popular opinion, especially in the West and South, demand a total change of base, which would make railroad management a socialistic rather than a business enterprise. There is a distrust of corporations as such, and a fear of the growth of corporate power. There is a belief that the present scale of charges is unnecessarily high, and that the people are taxed to pay dividends on watered stock. All these feelings are intensified by the fact that many of the railroads situated in some sections of the country are owned in entirely different ones, so that there is a local conflict of interests as well as an industrial one. Finally, there is a belief that if the government should own and manage the roads it would give better service and lower rates than we enjoy at present. It is a matter of feeling rather than knowledge, but it adds force to the agitation for lower rates by offering an alternative resource to the shipper and a menace to the corporation. Every convention of laborers in the city or of farmers in the country emphasizes this possibility ; every schedule of grievances, directly or indirectly, reflects this view of the matter. The last platform of the Minnesota Farmers’ Alliance contains this declaration : —

“We demand governmental control of railways, both by State and nation, to the end that all discriminations shall cease ; that reasonable rates shall be established ; that watered stock shall not receive the reward of honest capital; that the pooling of rates is such an element of monopoly as should be absolutely prohibited; that our legislature shall enact a freight-rate law which shall fix rates no higher than those now in force in Iowa, and the reduction of railroad passenger rates to two cents per mile. We anticipate the ultimate ownership of railroads by the government as the solution of this question.”

Nor is this state of feeling confined to any one country. It is part of the drift of uneducated public sentiment the world over. Here is a statement recently laid before the English Board of Trade, less comprehensive than that of the American farmers, but even more terse and explicit: —

“ What we want is to have our fish carried at half present rates. We don’t care a—whether it pays the railway or not. Railways ought to be made to carry for the good of the country, or they should be taken over by the government. This is what all traders want, and mean to try and get.”

II.

REASONS AGAINST GOVERNMENT OWNERSHIP.

Although the feeling in favor of eventual state ownership is so widespread, it does not seem likely that it will lead to any practical results in the immediate future. The American people have become accustomed to a standard of efficiency and economy in railroad service which no other railroad system has ever equaled. We do more work with fewer hands, and, on the whole, at lower rates. The very abuses which have crept into our railroad system only throw into stronger relief the superiority of corporate management as a whole. We hear constantly of watered stock and the inflated capitalization of railroads, but the waste due to government construction is more than the water due to private finance. The actual capitalization of the railroads of the United States is about $50,000 ¹ a mile. That of the government railways of New South Wales is just about the same. Yet the railways of the latter country are on a distinctly lower level than those of the United States. They have almost no double track; they run no fast trains; they accomplish no great feats of engineering. If we take a government system which stands on something like the same level as our own, that of Germany, for example, we find that it costs $100,000 per mile instead of $50,000. The same causes which interfere with economy of construction interfere also with economy of operation.

Under these circumstances, it is useless to expect as good results from state roads as from private roads, and a very short trial would be enough to prove it. If state roads were run without reference to the payment of interest, it would be not only a burden on the taxpayer, but a matter of outrageous favoritism which district should have roads built for its convenience, as is the case to-day with river and harbor improvements. If they were run with a view to profit, they would probably be managed on pretty much the same principles as private roads. There would be less elasticity of management and less readiness to introduce improvements, and the inferior economy of government ownership would prevent the building of lines and the establishment of train services which would barely pay under private corporations. All these results have been felt in Germany, where the rates are low, but the train service only one half as large as that of England, or one third that of the United States, while the handling of goods, the running of trains, and the introduction of modern appliances have been slow in the extreme.

Even in those cases where the government railroads of Europe seem to have done better than our own, the difference is apparent rather than real. The new tariff in Hungary, by which passengers are carried at little over half a cent a mile, is often quoted as an example of what America could and ought to do. But, in point of fact, Americans would not endure Hungarian service at Hungarian rates. If you have a large population, you can either carry the passengers in a few cheap trains, with enormous train loads, at very cheap rates ; or you can have more trains and better trains, with fewer passengers on each train, and higher rates of fare. The train mile is the unit of expense: if a given number of people are satisfied with few trains, they can get lower rates; if they want a great many trains, they must pay more. Which direction passenger traffic development will take depends upon the character of the popular demand. If time and comfort are more valuable to the traveler than a few cents’ difference in fare, he will pay a few cents more for time and comfort. If a laborer makes less than ten cents an hour, he can afford to lose an hour to save ten cents. If he makes more than ten cents an hour, time is money to him. The former is the case in Hungary or in India; the latter, in England or in America.

Cheapening of rates by reduction of facilities is just what the United States could not endure. Her commercial prosperity depends upon rapid development of railroad service, in quantity as well as quality. The popular feeling in favor of state ownership, widespread as it may be, is little more than a preference of unknown evils to known ones, — a preference likely to disappear at the point of actual trial.

III.

FORCED REDUCTIONS OF RATES.

The tendency toward enforced reductions of charge is, unfortunately, a much more real and immediate danger. Many of the States seem bent on repeating the experiences of the Granger legislation, half a generation ago. Iowa has already gone to the utmost limit of what is constitutional, if not beyond it; other States seem likely to do the same thing. Even the Interstate Commerce Commission has departed from the principle of simply securing equal rates, and tries to take final jurisdiction as to what is reasonable.

There are two ways of trying to reduce rates : by limiting profits, or by actually fixing a scale of charges. In most parts of the country public sentiment limits railroads to ten per cent dividends; in some cases the law reduces this to eight; the Farmers’ Alli ance measures propose six. These restrictions are often evaded by issue of new capital stock, either at less than its face value, or at any rate less than its market price. But even when enforced they commonly defeat their own ends. They discourage efficient business management by placing it on the same level with inefficient. They take away from a prosperous railroad the inducement to develop new business by lower rates and increased facilities. The assumption that the profit will be given back to the shippers in the form of cheaper rates never holds good. As far as there is any effect, it simply prevents reduction. As expressed by Sir Thomas Farrer, for many years secretary of the English Board of Trade : “The principle of limitation of dividend is in itself faulty. So long as the charge is not too high, the public have no interest in the reduction of dividend. Their interest is in the reduction of price, which is a totally different thing. The fallacy lies in supposing that what is taken from the shareholders necessarily goes into the pocket of the consumer. It does no such thing; it is probably wasted in extravagances, which the company have no motive whatever for reducing. Indeed, one of the worst consequences of the system is that it takes away inducements to economy. It leads not only to extravagance in current expenses, but to an extravagant waste of capital. In fact, in this parliamentary limitation of dividend and capital, we have gone on a perfectly wrong tack, and have involved ourselves in a maze of absurdities.” If the rate of profit were fixed as low as the Farmers’ Alliance demands, the effect would be even worse. It would simply prevent the investment of capital at all. If successful, it is to be limited to a low rate of profit; if unsuccessful, it would have to take all the risks of loss. It would simply be a death-blow to business enterprise.

While laws limiting profits defeat their own ends, those limiting charges attain their immediate object at the sacrifice of other more important ones. A community can have what transportation it is willing to pay for. If it lets the roads make what rates they please, it can have railroads in every section which can afford them, and facilities for every line of business which can possibly pay for transportation. If, on the other hand, it seeks to limit charges, it can only have the facilities where traffic is densest and most profitable. In proportion to population, it will have fewer roads and fewer trains. Fix a limit of charge by law, and the amount of service adjusts itself to that limit.

The economic principles involved in fixing railroad charges are not radically different from those involved in fixing the price of bread ; it is only that their operation is slower and more obscure, and that the public has learned the lesson less completely. There was a time when it was thought necessary to have the public authorities fix the price of bread. People feared that, if matters were left to themselves, the sellers would have a monopoly, and take every advantage of the needy buyers. But, as time went on, it was found that such laws did more harm than good. If the price was fixed too high, it was useless ; if it was fixed too low, the supply of bread fell short of the demand, and while some people got their bread cheap, others got none at all. The suffering of the latter class was greater than the advantage to the former. A new system gradually superseded the old. Sellers were allowed to get what price they could, buyers to pay what price they would. In that way, and in that way only, was there an adjustment of quantity of service to public demand.

The same thing has happened in the case of railroads. Under the influence of the Granger movement, from 1870 to 1875, laws were passed limiting railroad charges to what the shippers desired. The first effect was to give the farmers a chance to ship their goods at lower rates. But this did not last long. Railroad facilities ceased to develop as they had done before. When the companies could not pay interest, the building of new roads stopped, and the service on the old ones deteriorated rapidly. Some men were able to ship cheaper, but others were unable to ship at all. The loss to the latter far outweighed the gain to the former. The development of the States which had passed restrictive laws was checked ; the more stringent the law, the more severe the reaction. The laws were either allowed to fall into disuse, or, in some cases, were repealed by the very men who had passed them. Long before the Supreme Court had had time to pass on the constitutionality of such legislation, the logic of events had proved that it was destructive to the very interests which it was designed to protect.

The same thing must repeat itself to-day. Although the greater size of our consolidated systems renders the reaction against the legislation of any one State less speedy and obvious, our roads as a whole are working too near the margin of profit to endure reduction of charge anywhere without corresponding reduction of service. Their net earnings are only a little over $2000 a mile. A slight reduction will be enough to cut off the supply of capital for new roads, and to limit the service on old ones. Any such change must make itself quickly felt by the shippers. We have not been building new lines with any great rapidity since the close of 1887, so that the supply of transportation service is not very largely in excess of the demand. If this slight excess were converted into a deficiency, it would be a quicker and more effective means of checking radical legislation than any influence which can be brought to bear through the courts or upon the legislatures. While the courts may pronounce, and in some cases have pronounced, such legislation unconstitutional, they are as a rule disposed to give it the benefit of the doubt. If it complies with certain forms of procedure, they will not stand in the way of its operation, unless it has been found actually to work serious damage. The railroads must “ prove poison by taking it.” From the legislatures there is even less hope. The attempt which has been made in some quarters to use corruption as a means of fighting such legislation is worse than useless. It simply puts it into the power of every corrupt man to blackmail the companies, and adds a new source of danger to those already existing. It is on themselves, rather than on the public authorities, that the investors must rely for protection.

IV.

THE PROBLEM OF CORPORATE CONTROL.

The action of investors has been, and still is, seriously hampered by the fact that those who are put in charge of the property and who ought to be representatives of their interests are not really so. This criticism does not apply merely to those who have acquired control of the property by dishonest methods, with the intent of sacrificing legitimate owners. It applies to many railroad directors and presidents who are thoroughly honorable men, but have no special fitness for the position in which they are placed.

The investors are interested in the successful operation of the property. Their representatives whom they place in control are often more immediately interested in the purchase or sale of certain securities connected with it. They operate in Wall Street rather than in the railroad itself. Their interest is a speculative one. Even when they hold a large share in the securities, they contemplate the possibility of selling them at an advance. If they are at all dishonest, they are likely to be still more interested in outside corporations whose interest is adverse to the property which they nominally represent. This is not at all universally so. There have been great financiers, like Vanderbilt, who were also great railroad men. But, as a rule, a large part of the control of our great properties is in the hands of men who are dealers in railroad securities rather than legitimate investors in railroads. It is one of the most serious charges which can be maintained against our financial system that so much money is to be made in the former way, and so little in the latter.

While such leaders have often shown great shrewdness in matters of temporary importance, they have too frequently neglected what was of the greatest value to the permanent interests of the property. Their horizon has lain within the limits of the year’s balance sheet. They have known little of the feeling among the employees of the road, and have had little of the instinct of leadership which would cultivate esprit de corps or prevent disaffection and strikes. They have known to some extent how to deal with corrupt legislatures ; they have not known how to deal with the public opinion along the line, uncorrupt but unenlightened, which renders the action of such legislatures dangerous. They know how to make combinations for their own financial purposes ; but of the methods by which a combination is made to secure good railroad economy or steadiness in rates they know little or nothing.

This defect has made itself strongly felt under the operation of the pooling clause of the Interstate Commerce Law. While the law as a whole imposed new duties on railroads, the prohibition of pools took away one of their chief means of performing those duties. They were charged with the responsibility of treating all shippers alike. But when a single large shipper, or a combination of shippers, threatened to divert enormous quantities of freight from one road to another, and thus cause great loss to a company which would not accede to a demand for special favors, the railroads were forbidden to combine to protect themselves. Or when a single reckless agent, acting perhaps in defiance of instructions, made secret concessions which secured freight for his line, the other roads were compelled either to follow suit, or to see the traffic diverted to the least law-abiding among them. The Interstate Commerce Commission was practically powerless to protect them. Previous to the passage of the act they had avoided this evil by a division of traffic or earnings according to percentages. Now, however, in the words of the general manager of one of the roads which had made the strongest effort to conform to the law, “ the old and tried methods, imperfect though they were, were legislated out of existence.”

Partly as a result of this cause, partly from the reckless over-construction of roads in 1887, the net earnings of the Central and Western systems began to fall rapidly. Investors were unwilling to buy railroad securities, old or new. Those who made their profit from dealings in such securities found their market gone. They tried to restore public confidence by the " Gentlemen’s Agreement,” whose outcome was the Interstate Commerce Railway Association. A stenographic report of the proceedings of their conferences has been preserved. It reads more like congressional debates than like sober talk of sensible men. The participants were thinking of what they wanted to accomplish rather than of the practical means of attaining it. They were aiming to gain public confidence rather than to deserve it; and anybody who tried to bring the latter point into view, or ask how they proposed to carry out any of the difficult parts of their programme, received about as much encouragement as he would if he asked the same question about a platform in a party convention. There was much talk of harmony, but no means of securing it; some provision for boards to control nominal rates, but no system of joint agencies or traffic arrangement which should insure that the real rates were anywhere near the nominal ones.

Had the public allowed its confidence to be restored by so transparent a device, it would have been the worst thing which could have happened. The association, in spite of the ability of its chairman, has been a pretty complete failure, and before these lines appear in print will have been considerably remodeled. There seems to be danger that in the new association, as well as in the old, there will be a high standard of nominal requirement combined with comparatively slight means of enforcement. Thus far the unwillingness of the public to buy securities, resulting as it does in a lessened supply of transportation facilities, has been more of a protection against future rate-cutting than all the combinations of Western roads. If this unwillingness continues, the financial authorities now in control will have to turn their attention less to the market, and more to improvements in the method of operation. When it becomes impossible to sell a road to advantage except by operating it to advantage, the interests of the financier and investor will cease to conflict.

Another encouraging sign is the agitation for important reforms in corporation law. In some respects the law has hitherto been about as bad as it could be. Stock has been issued for no consideration, or a grossly inadequate one. The actual investment has been furnished by bondholders, while the stockholders obtained absolute temporary control of other people’s money. If dishonest, they could give themselves lucrative contracts at the expense of the real investor. Even without actual dishonesty they could commit a company to an unwise policy, from which it would take many years to recover. There is room for law reform in all these matters. The position of a director of a great corporation is in large measure that of a trustee. In England it is treated as such, and he is forbidden to use the money of the corporation for contracts in which he is personally interestedWhile it might not be practicable to go as far in this country, the responsibility of the directors could be largely increased, and such contracts surrounded by safeguards which are now conspicuously absent. It is strongly urged in some quarters that the bondholders, furnishing as they do so large a share of the investment, should be given a voice in the management. As compared with the present state of things this would be an improvement, but it might be wiser to deal with the evil one step further back, and insist that the bondholders should not furnish so large a share of the investment as they now do ; that the amount of money actually invested by stockholders should at least equal the amount of bonds issued, so that the latter should be reduced within a fair limit of risk, and should really be what they pretend to be, an investment security.

No matter how much the law may do, the main hope of reform must be in the increased intelligence of the investors themselves. We have learned that representative government cannot be made a success in politics unless the voters have a sufficient degree of enlightenment to manage it. We must learn the same lesson in industry. With the increasing tendency toward monopoly due to modern commercial methods, the chance for mistakes becomes greater, and the demand for intelligence more exacting. Unless the stockholders learn to use their votes and their rights, the management of industry will tend to give more and more irresponsible power to individuals ; the relations between our political theories and our business practice will become more and more discordant ; the demand for state socialism will grow more and more powerful. To keep control of large industries without the most disastrous conflicts investors must show themselves worthy to exercise it.

Arthur T. Hadley.