Railroaded by Needless Regulation? STB’s Proposals Will Impact Small Business Customers and Suppliers

By at 22 November, 2019, 9:36 am

by Raymond J. Keating-

If the intention is to undermine investment, entrepreneurship and innovation, then one of the surest public policy means to do so would be imposing price controls. After all, when government regulates the price of a good or service, that means government limits the potential returns on such endeavors, and creates political risks and uncertainties. That’s a clear recipe for disincentivizing investment.

The history of freight railway in the United States serves as a case study of regulation run amok and the positive results when at least partial deregulation occurs. Unfortunately, there is movement to go down the path of misguided and costly regulation once more. That would be bad news for freight railroads, and for the small businesses that operate in railways sectors and for the seemingly countless small businesses served by rail freight.

As SBE Council explained in two recent studies – Railroads and Small Business – Cull the Outdated Regulation and Embrace Greater Opportunity (2019) and All Aboard! Entrepreneurs and Small Business Power America’s Freight Railroads (2018) – when government imposed heavy, intrusive regulations on the railroad industry that limited pricing flexibility, and prohibited restructuring of railroad systems, the results featured faltering investment, lost innovation, degraded equipment and systems, deteriorating safety, and bankruptcies. Positive changes arrived when policymakers went in a different direction, as noted in SBE Council’s 2019 “Railroads and Small Business” report:

“After a mistaken and costly step in nationalizing a variety of failed railroads, the railroad industry only returned to health and profitability after Congress passed and President Jimmy Carter signed into law the Staggers Rail Act of 1980. The Staggers Act partially deregulated railroads in terms of setting prices for services and setting rail rates, making decisions regarding what routes to use, and establishing shipper contracts, that is, allowing freight railroads to make decisions based on market conditions.

“The changes were positive and dramatic for the railroad industry in terms of efficiency and productivity, capital investment, maintenance and safety, market share, profitability, and reduced costs and enhanced service for customers.”

Nonetheless, the lessons of over-regulation never seem to completely learned, and the push for increased regulation never seems to go away. When government is large and activist, the incentives for rent seeking – that is, using government to in effect take wealth from others – are substantial. Assorted parties try to gain advantages by having government interfere with competitive markets. Indeed, it is rent seeking that has driven much of the vast expansion in regulation since the late-nineteenth century, including efforts to regulate aspects of freight railroad services.

STB Moving Backwards on Regulation

Current proposals from the Surface Transportation Board (STB), which is responsible for regulating the economic dealings of railroads, could alter the regulatory equation in a counterproductive way.

For example, the STB will hold a public hearing on December 12, 2019, on revenue adequacy issues. The 2019 SBE Council report raised serious questions about the use or abuse of “revenue adequacy” regulations:

“Perhaps even more blatant is an effort by various large shippers to use the ‘revenue adequacy’ calculation to cap rates that railroads can charge, in effect, imposing price controls.

“As AAR has explained: ‘Railroad revenue adequacy is a calculation developed and used by the Surface Transportation Board to assess the financial health of individual railroads. The calculation, which compares an individual railroad’s Return on Investment (ROI) with the railroad industry’s Cost of Capital (COC), measures whether the return a railroad earned was sufficient to attract investment capital. Revenue adequacy calculations are reported annually to Congress.’

“The idea behind revenue adequacy calculations was to provide regulators with a measure of financial health for railroads, to see if Class I railroads were earning adequate revenues after decades of suffering under over-regulation before the Staggers Act. However, it has gradually been transformed, and could be further expanded, as a tool to regulate rates. Such an effort comes with an assortment of problems, including, for example, using book value to determine the industry cost of capital as opposed to the replacement value.

“In the end, the imposition of price controls always results in reduced investment. After all, why would investors put their financial capital to use in an industry where government can limit returns?”

In addition, the STB issued a Notice of Proposed Rulemaking on September 12, 2019, focused on a new procedure – “Final Offer Rate Review” – for rate reasonableness challenges whereby the STB would decide a case via an expedited schedule by selecting either the complainant’s or the defendant’s final offer. At first glance, this might seem like a sound proposal meant to simplify and reduce the amount of time on the case. However, look a little closer, and major problems become evident.

Strange Regulatory Assumptions and Objectives, Unintended Consequences

First, the STB’s stated objective for taking this action is effectively to increase the number of complaints, that is, to increase regulatory interference in the workings of the market at the behest of rent seekers. The stated objective is: “By lowering the costs of litigating smaller rate cases, the Board expects that complainants with smaller rate cases, who otherwise might have been deterred from challenging a rate due to the cost of bringing a case under the Board’s existing rate reasonableness methodologies, would have a more accessible avenue for rate reasonableness review by the Board.” That might sound nice, but the effect is to raise regulatory interference, costs and uncertainties. That, in turn, reduces the resources, ability and incentives for investment and innovation.

In fact, the STB seems concerned that not enough complaints are being filed. The Board apparently takes that as evidence of unreasonable barriers to registering complaints. But this is a mere assumption. A perceived lack of complaints more likely simply reflects that market rates are reasonable.

Second, when replacing a process that involves a full hearing and attempts to replicate market outcomes with an either/or decision, not only are questions raised about denying due process and straying from governing statues, but risks are raised enormously for railroads, as shippers would have the upper hand without any downside risks. Again, incentives to seek government interference would be greatly enhanced.

Third, the STB says this is about small shippers and small claims, with a limit of $4 million in relief per case. Of course, $4 million is anything but small, and given that shippers can bring multiple cases, the ability to rack up considerably larger benefits for shippers and liabilities for railroads is easy to envision.

This “Final Offer Rate Review” plan is rooted in an arbitrariness, skews incentives, and creates a bias toward increased regulation. All of this ranks as more than sufficient cause for rejecting this proposal.

There’s No Rationale for Intrusive Government Regulation

To close out this look at assorted problems with ramping up railroad regulations, it is worth relaying the concluding points from the SBE Council 2019 report on the realities of competition in the transportation marketplace:

“Finally, in considering these and other legislative and regulatory challenges, it must be kept in mind how broadly competitive the freight transportation marketplace is, encompassing trucks, rail, water, and air, not to mention the changes that customers can make in response to seemingly countless factors, including shipping options. The future transportation market can be reasonably expected to feature driverless trucks, autonomous drone shipments and autonomous vehicles.

“For good measure, The American Consumer Institute Center for Citizen Research noted: ‘While Class I railroad operators frequently compete head-to-head amongst other railroad operators, they are also subject to substantial intermodal competition. In 2015, distribution of transported freight (in tons) was 66% by truck, 19% by pipeline, 9% by rail, 4% by water and 2% by multiple modes. Rail represents only 3% of revenues among all modes of freight transportation, and its share of freight (in tons) was less than 30% for any of 16 major commodities listed by the U.S. Department of Transportation, apart from solid coal (61%), now in decline.’

“These market realities, and the dynamic nature of markets, stand as formidable opponents to government interference and regulation in the name of ‘competition.’ Indeed, the most vocal proponents for ‘reform’ at the STB, for instance, are in fact calling for increased government involvement in the private marketplace – absent justification – to spur so-called competition. As noted earlier, freight shipments are expected to grow substantially in coming years. Everyone would benefit from establishing a policy environment that fosters investment, efficiency, productivity and innovation.

“Clearly, freight railroads, their customers, consumers in general, and the small business community – including small businesses in the railroad sector, serving railroads, and as customers of freight rail – have benefited from moving away from intrusive, unwarranted and costly regulation. Today’s policy objectives should have nothing to do with turning back the clock to destructive regulatory policies.

“Instead, policymaking should be focused on providing relief from unnecessary governmental burdens, such as via tax and regulatory relief, and free trade policies that reduce barriers like tariffs and quotas. That’s the kind of policymaking that will expand investment, innovation, and competition; enhance opportunities for entrepreneurs, small businesses, and their employees; and boost the overall economy.”

A BIG Small Business Issue, With Harmful Effects

Regarding entrepreneurs, small businesses and their employees, the roles of small business must be noted. As noted in the 2019 report, when looking at 13 industry sectors directly or indirectly affected by freight railroads – from support activities for rail transportation to retail trade to manufacturing in general to railroad rolling stock manufacturing to construction – in all but one, the majority of employer firms were small businesses with fewer than 20 employees – ranging from 51.6 percent of firms in the warehousing and storage sector to 93.4 percent in the agricultural sector. Meanwhile, the one sector falling short of a majority – railroad rolling stock manufacturing – still registered 46.8 percent of employer firms with fewer than 20 employees.

For good measure, in all 13 sectors, firms with fewer than 100 employees made up at least 69 percent of employer firms – ranging from 69.0 percent in railroad rolling stock manufacturing to 98.9 percent in construction.

So, whether serving or being served by freight railroads, investment and innovation in the railroad industry matters a great deal to U.S. small businesses. Therefore, the small business community is affected negatively when over-regulation inflicts harm on railroads, with the result being less investment, innovation, competition, choice and dynamism.

Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council.


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