May 16, 2017

Infrastructure Policy: Four Lessons from Freight Rail Deregulation

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Policy discussions about infrastructure, which includes roads, bridges, airports, and railways, often presume that major infrastructure must be government funded and government owned. But the United States boasts one of the largest examples of privately owned and privately funded infrastructure systems in the world: freight railroads. In 2015, freight railroads spent about $27 billion on maintenance, modernization, and expansion. The Association of American Railroads estimates that railroads have invested more than $630 billion in their networks since 1980. To put that number in perspective, Robert W. Poole Jr. estimates it would cost $589 billion (in 2010 dollars) to replace the existing interstate highway system.

It wasn’t always this way. In the 1970s, federal regulation was driving railroads out of business. Toward the end of the decade, bankrupt railroads operated 21 percent of the nation’s track. To preserve rail service in the Northeast, the federal government purchased the bankrupt Penn Central and other northeastern railroads in 1976 to create Conrail. Congress faced a choice: spend billions of dollars annually to subsidize rail service, or remove most economic regulation so that railroads could become self-supporting. Congress chose deregulation.

The Staggers Rail Act of 1980 eliminated most rate regulation, allowed railroads and shippers to sign confidential contracts, and established time limits for regulators to approve discontinuations of unprofitable service and mergers. For the next two decades, railroad productivity soared, allowing most railroads to become profitable while reducing rates for most commodities. Several economic lessons that emerge from this success story are relevant to the broader policy debate over infrastructure in America.

LESSON 1: REMOVE BARRIERS TO INNOVATION

Regulation impeded innovations that allowed railroads to move more freight on the existing rail network. For example, in the 1960s, Southern Railway sought to introduce large covered hopper cars—nicknamed “Big John” cars—to carry grain. The railroad needed to reduce rates to induce grain shippers to make some complementary investments to load the cars—and Southern had to litigate all the way to the Supreme Court to get permission to reduce the rates!

After the Staggers Act, however, railroads could sign contracts that gave shippers lower rates if the shipper furnished enough volume to fill an entire “unit train.” Another major innovation that was facilitated by contracting under deregulation was intermodal service: trailers and containers were transported on flat cars so that containers could easily be moved to a truck and driven away. Intermodal service allows railroads to carry more freight, and it expands highway capacity by getting trucks off the road for most of the route.

The broader lesson is that policymakers should avoid regulations that impede innovations that would effectively expand the capacity of existing infrastructure. For example, driverless cars could allow existing roads to transport more people with less delay. But the National Highway Traffic Safety Administration has proposed that driverless cars should be subject to a premarket approval process in place of the current manufacturer self-certification process for automobiles. Such a hurdle could delay significant safety and economic benefits.

Similarly, the Federal Aviation Administration bans supersonic flight over the continental United States, even though improvements in engineering and materials could allow smaller supersonic aircraft to comply with reasonable noise standards. Unmanned aerial vehicles (drones) could speed delivery of packages and take some freight off the nation’s roads, but current regulations hamper their use by requiring that drone operators maintain visual contact with the drone, even though more reliable collision-avoidance technologies are available.

LESSON 2: AVOID MANDATING COST RIGIDITIES

Railroad productivity more than doubled in the 13 years after the Staggers Act, and operating costs per mile fell by half. Most of these gains occurred because deregulation removed rigidities that prevented railroads from reducing costs. For example, railroads could more easily end service on lines that did not cover their costs, including the cost of capital. In some cases, these lines were spun off to lower-cost regional and short line railroads.

Other forms of infrastructure still suffer from regulatory cost rigidities. The Davis-Bacon Act requires that all workers on federal construction projects must receive the “prevailing wage” in the locality, which tends to inflate construction costs. Thirty-two states have similar legislation that applies to state projects. The “Buy America” program requires use of domestically produced materials for transportation projects unless they would increase costs by more than 25 percent. In-state preference policies—the state version of “Buy America” laws—environmental assessments, and various strings attached to federal funding also increase costs. A recent Mercatus study notes that federal regulations increase the cost of transportation projects by between 10 and 30 percent.

LESSON 3: MATCH PAYMENT WITH USE AS DIRECTLY AS POSSIBLE

In freight rail, the link between use and payment is pretty tight: if a shipper is not willing to pay, the railroad does not have to move the freight. Moreover, the ratemaking freedoms introduced by partial deregulation ensure that no railroad is forced to carry freight that does not cover its cost, and no shipper has to subsidize another shipper.

Pricing of other transportation modes is not so rational. Highways are largely financed by the gasoline tax, which has no link to the particular roads a driver chooses to use at a particular time. Charging actual prices, in the form of tolls, would better match payment with use. A Reason Foundation study estimates that all but six rural states could raise enough money to finance reconstruction of their interstate highways using tolls.

LESSON 4: ALLOW PRICES TO VARY WITH DEMAND

Partial economic deregulation allowed railroads to charge different customers different prices depending on demand. In practice, this usually means charging higher rates for customers with no competitive transportation options and lower rates to retain the business of customers that have attractive transportation options. Although this type of differential pricing has generated concerns about the reasonableness of some shippers’ rates, it has been a key ingredient in making the freight rail network self-supporting.

Similarly, demand-based pricing could help other transportation infrastructure cover its full cost, and sometimes provide other social benefits as well. For example, real-time pricing of highways (such as the high-occupancy toll lanes on the Washington, DC, Beltway and I-395) can generate revenue to pay for the roads while reducing congestion. Sensors in parking spaces enable local authorities to adjust parking prices on the basis of demand, reducing congestion caused by motorists searching for parking spaces. Congestion pricing for takeoff and landing rights at airports could likewise generate revenue and reduce congestion.

Applying these four lessons could move the United States much closer to an efficient, innovative, and user-supported transportation system.