New rail study: “Policy must tolerate market power”
Written by Frank N. Wilner, Capitol Hill Contributing EditorFor more than three decades, railroad regulators have used the same method to determine which shippers are captive; and, if so, to determine a remedy to limit railroad market power and assure rates charged captive shippers are reasonable.
The process—part established by Congress and part by the Interstate Commerce Commission and its successor, the Surface Transportation Board (STB)—is complex, lengthy, expensive and rarely understood outside the small army of attorneys, accountants, economists, financial experts, specialists in railroad operations, statisticians and other technicians who collectively pocket millions of dollars to represent shippers and railroads through a process so convoluted that only the prince of convolution, engineer Rube Goldberg, could love it.
Shippers, although they have won more rate reasonableness cases than they have lost, long have sought a better, cheaper and faster protective process. Grain shippers, for example, haven’t filed a rate grievance since 1981, even though they are among the most vocal in asserting railroads abuse their market power. The cost of pursuing a regulatory remedy too often exceeds the benefits, say many shippers whose transportation options are mostly limited to one railroad.
The two current STB members—Acting Chairman Deb Miller, a Democrat, and Republican Ann Begeman, both from rural agricultural states—also criticize the existing process for protecting captive shippers. “The board has a duty to ensure that shippers have a viable means to challenge a rate,” Begeman said in a recent dissent. “I already know that is not the case for grain shippers.”
In Congress, where shippers are said to have overplayed their hand in seeking what is broadly seen as an attempt to reverse the 1980 Staggers Rail Act, which partially deregulated railroads, support nonetheless exists to simplify, make less costly and speed up rate complaint cases filed by captive shippers. For sure, the eyes of congressional lawmakers and their staff often glaze during explanations of how the regulatory process for adjudicating shipper rate complaints plays out before the STB.
At the core of the complexity, cost and calendar issue are seemingly conflicting congressional objectives imposed as part of the Staggers Rail Act. The law was passed at a time the rail industry was rife with bankruptcies, faltering service, retreating investors and fewer prospects. Today, the Staggers Rail Act is celebrated for its success in restoring to railroads financial self-sufficiency. So much has changed in the intervening 35 years.
On the one hand, the Staggers Rail Act instructed regulators to ensure that railroads can earn enough revenue to continue to operate and invest—known as revenue adequacy. At the same time, Congress instructed regulators to ensure rail shippers can obtain adequate service at reasonable rates.
Amidst growing displeasure with the time-honored, if not time-worn, process used by rail regulators to achieve those objectives, Congress instructed the Department of Transportation to undertake a study of the situation and make recommendations for improving the regulatory process. DOT handed the assignment to the National Research Council’s Transportation Research Board, congressionally chartered as an independent nonprofit entity. A team of seven Ph.D. economists, under the direction of Massachusetts Institute of Technology (MIT) economist Richard Schmalensee, performed the study. (Schmalensee, MIT ’65 and Ph.D ’70, is Howard W. Johnson Professor of Management, Emeritus; Professor of Economics, Emeritus; and Dean Emeritus.)
They concluded that “current policies designed to protect rail shippers who lack transportation options from excessive rates are not working for shippers of most commodities, including grain. More appropriate, reliable and useable procedures are needed to resolve these rate disputes without threatening the earnings railroads need to pay for their capital-intensive networks.”
For sure, this is not a put-up job with built in biases and outside influences. Any notion that the recommendations are shipper friendly should be dashed by comments of Schmalensee in an exclusive interview June 9 with Railway Age.
Schmalensee spurned, for example, a petition of the National Industrial Transportation League (NITL) asking that the STB artificially create two-railroad competition by forcing railroads that sole-serve a shipper facility to open their tracks for use by a competing carrier. “We see no case now for wholesale competitive switching,” he said. “We can’t go down that road. We don’t know enough.”
He also defended the use by railroads of differential pricing, whereby shippers displaying the greatest dependency on efficient and safe rail transportation pay a higher percentage of a railroad’s overhead costs than shippers who more easily might shift to trucks or barges. “Policy must tolerate market power, which we do in the interests of efficiency,” Schmalensee said. “We want to regulate against extreme abuses. We think it could be done better than it is—not tighter, but smarter.”
Since late May, the recommendations have been shared confidentially with House and Senate staff on committees with rail transportation oversight, as well as with senior staff at the STB and its board members. The 173-page study, recommending modernization of rail regulatory procedures, was to be made public Wednesday, June 10, 2015, at an STB hearing in Washington, D.C.
Many of those who have already read and digested the study confirmed to Railway Age that its recommendations surely will require congressional action in the form of legislation. Schmalensee indicated that the Senate Commerce Committee is unlikely to pursue those recommendations directly this year as amendments to STB reauthorization legislation (S. 808). But such language could be added, instructing the STB to provide guidance on how the recommendations might be fleshed out in new legislation and in regulatory rulemakings.
For more information on S. 808, which has the support of railroads and most rail shippers, use this link:
Among the recommendations of the study, formally titled, “Modernizing Freight Rail Regulation”:
• Scrap the congressionally created 180% of variable costs threshold that triggers whether a railroad is market dominant. That trigger currently permits a shipper to petition the STB for rate relief. The percentage figure has no basis in science or economics and is known literally to have been randomly selected when writing the Staggers Rail Act.
• Scrap the annual railroad revenue adequacy test performed by the STB as required by the Staggers Rail Act. “It is not providing any useful information for policy, [only] ammunition for rhetoric,” Schmalensee said.
• Scrap the Uniform Rail Costing System (URCS), which measures various categories of rail costs. “URCS uses a whole set of arbitrary judgments, saying, for example, that 25% of ton-miles are moving below variable costs,” Schmalensee said. “That is crazy that railroads are losing out-of-pocket on 25% of ton-miles. Nobody would do that.”
• Scrap the complex, costly and time-consuming stand-alone cost (SAC) test for determining rate reasonableness. Of the SAC, Begeman said in a 2014 dissent, “While I had been skeptical about the SAC test prior to my service at the Board, my concerns have only grown as I have seen the SAC process in action.”
• To determine market dominance, compare a captive shipper’s complained-of rate with non-regulated traffic and contract rates on similar commodities moving in similar traffic lanes. “The model will never find a matched pair,” Schmalensee said, “but it will look at coal shipments, including competitive alternatives, contracts, ton-mile rates, volume and distance, and ask, ‘what does that predict?’ It will not be precise. No two shippers are the same.”
• “Don’t assume market dominance for every rate above the predictive comparison. Just look at those way above,” Schmalensee said. Precisely where, he could not say. “If we only look at rates seven times the competitive prediction, then that is bad for shippers. But if we look at anything 20% above the competitive prediction, it is lousy for revenue adequacy.
• Don’t force all non-competitive rates to the level of observed competitive rates “because the recommendation is not to gut differential pricing,” Schmalensee said. “We cannot imagine walking back from differential pricing. Shippers are entitled to not paying a whole lot more than someone shipping over a similar path. A notion of fairness does not embrace huge differences of what someone pays for the same thing. How big a discrepancy do you look at? There is no scientific answer.”
• Where railroad market dominance is being considered, railroads would be allowed to assert product and geographic competition—a defense that an electric utility can substitute natural gas for coal and thus isn’t captive to a railroad for its fuel source; or that wheat can be shipped from a multitude of origins served by other railroads.
• Where railroads are found to be market-dominant and rate relief might be justified, final-offer arbitration would commence. Railroads and shippers would present their case—“their best shot,” Schmalensee said—and the arbitrator chooses one of the two alternatives. “In presenting cost evidence, railroads would be allowed to argue for replacement costs [as opposed to historical costs favored by shippers]. Shippers could argue for a lower rate and even competitive access. The arbitrator would make a choice, placing pressure on each party not to seek too much lest the other party’s position prevails as more equitable.”
It is with binding arbitration that things get dicey, with Schmalensee conceding economists are neither attorneys, lawmakers nor policy wonks.
For example, a recent Supreme Court decision carried lengthy concurring opinions by Justices Samuel Alito and Clarence Thomas concluding that delegating binding, tie-breaking authority to a private arbitrator is not constitutional; that such decisions must be made by individuals who are “accountable to the people” by virtue of their being confirmed by the Senate.
If such is the case, arbitrator decisions would have to be reviewed by Senate-confirmed members of the STB; and once that occurs, the STB decision would be subject to federal court appeal. Such a result is at odds with the intention to make the process less complex, less costly and faster.
Former STB Chairman and Democrat Dan Elliott—awaiting a Senate confirmation vote to return to the STB—has essentially defended, in his decisions, the three-decades-old processes this study seeks to modernize. But Republican Begeman essentially has asked, in dissents, “Why are we always doing what we did before?” Democrat Miller is understood to be asking that same question of STB staff.
This congressionally requested study and the recommendations made public June 10 is best described as “a game changer.” For the first time in three decades, an independent group of economists, with no visible conflicts of interest or bias, has essentially called the current process of adjudicating shipper rate complaints “a mess.” They recommend a new process, which may not be too difficult to oppose given that numerous attempts to simplify, make less costly and speed-up the existing process have failed and have few supporters.
Yet the most significant hurdle to achieving a new process such as recommended is that the current process is so engrained in law and politics that finding converts will be difficult. As oft is said of change, “It is easier to say something should be changed than to make it work.” Or as original Internet engineer Yakov Rekhter lamented, “Short-term solutions tend to stay with us for a very long time. And long-term solutions tend to never happen.”
We know of one 20th century railroad CEO and visionary who fought that battle his entire career, refusing to be discouraged. Said Alfred E. Perlman, an MIT-trained engineer, “After you’ve done a thing the same way for two years, look it over carefully; after five years, look at it with suspicion; after 10 years, throw it away and start all over.”
Association of American Railroads President and CEO Edward R. Hamberger provided the following response to the report: “The TRB report is a solution in search of a problem. The United States already enjoys the most efficient, safest freight rail network in the world. In fact, freight rail customers today pay rates that are on average 43% less than they paid in 1980. The report is a theoretical exercise that would upend the real-world concrete successes achieved since the Staggers Act passed in 1980.”
To download a copy of the study, click HERE.
