337. BASIS OF NATURAL MONOPOLY.—The most important examples of natural monopoly are found in those industries which are known as public utilities. Public utilities include gas and electric light works, waterworks, telephone and telegraph plants, and electric and steam railways.

These industries are by their very nature unsuited to the competitive system. This is chiefly because they operate under the principle of decreasing cost, that is to say, the greater the volume of business handled by a single plant, the less the cost of production per unit. In order to serve 100,000 customers with gas, for example, it may be necessary to make an initial outlay of $90,000 in plant and supplies. With this identical plant, however, the gas works could really manufacture gas sufficient to serve more than 100,000. If, later, the city grows and the number of customers using gas doubles, the gas works, already having its basic plant, will not have to expend another $90,000, but only, say, an additional $30,000.

This principle has the double effect of virtually prohibiting competition and of encouraging combination. Since a street or a neighborhood can be served with water or gas more cheaply by a single plant than by several competing plants, competing plants tend to combine in order to secure the economies resulting from decreasing cost and large-scale production. On the other hand, the cost of duplicating a set of water mains or a network of street car tracks is so prohibitive as to render competition undesirable, both from the standpoint of the utility and from the standpoint of the public.

This natural tendency toward monopoly, together with the social importance of public utilities, has given rise to a demand that businesses of this type be publicly owned. The problem of public ownership may be considered under two heads: first, the municipal ownership of local utilities; and, second, the national ownership of steam railroads.

A. MUNICIPAL OWNERSHIP

338. REGULATION OF LOCAL UTILITIES.—In many American cities it was formerly the custom of the city council to confer valuable privileges upon public service corporations on terms that did not adequately safeguard the public interest. In making such grants, called franchises, city councils often permitted private corporations the free use of the streets and other public property for long periods of time or even in perpetuity.

The abuses growing out of the careless use of the franchise granting power have recently led to a more strict supervision of franchises to public service corporations. In most cities, franchises are no longer perpetual, but are limited to a definite and rather short period, say fifty years. To an increasing extent, franchises are drawn up by experts, so that the terms of the grant will safeguard the interests of the public. In many states there are now public service commissions that have the power to regulate privately owned utilities. The chief aim of such commissions is to keep informed as to the condition of the utilities, and to fix rates and charges which the commission considers fair and reasonable.

339. ARGUMENTS FOR MUNICIPAL OWNERSHIP.—Those favoring municipal ownership, as opposed to regulation, declare that the conditions affecting rates change so rapidly that no public service commission can fix rates fairly or promptly. Public ownership would save the cost of regulation, in many cases a considerable item. It is maintained that regulation is inevitably a failure, and that in view of the social importance of public utilities, ownership is a logical and necessary step.

Important social gains are claimed for municipal ownership. It is said that where the plan has been tried, it has promoted civic interest and has enlisted a higher type of public official. If all utilities were municipally owned, state legislatures and city councils would no longer be subjected to the danger of corruption by private corporations seeking franchises. If utilities were owned by the municipality, it is claimed, service and social welfare rather than profits would become the ideal. The public plant could afford to offer lower rates, because it would not be under the necessity of earning high profits. Finally, service could be extended into outlying or sparsely settled districts which are now neglected by privately owned companies because of the high expense and small profits that would result from such extension.

340. ARGUMENTS AGAINST MUNICIPAL OWNDERSHIP.—Other students of the problem believe that public regulation of utilities is preferable to municipal ownership. Those holding this view maintain that on the whole regulation has proved satisfactory, and that ownership is therefore unnecessary.

Rather than improving the public service by enlisting a higher type of public official, it is maintained, municipal ownership would increase political corruption by enlarging the number of positions which would become the spoils of the political party in power. The periodic political changes resulting from frequent elections in cities would demoralize the administration of the utilities. Under our present system of government, municipal ownership means a lack of centralized control, a factor which would lessen administrative responsibility and encourage inefficiency.

The opponents of municipal ownership also contend that the inefficiency resulting from this form of control would increase the cost of management. This increased cost would in turn necessitate higher rates. Moreover, municipal ownership might increase enormously the indebtedness of the municipality, since either private plants would have to be purchased, or new plants erected at public expense.

341. EXTENT OF MUNICIPAL OWNERSHIP.—Some cities have tried municipal ownership and have abandoned the scheme as unworkable. In some instances this failure has been due to the inherent difficulties of the case, in other instances the inefficiency of the city administration has prevented success. In still other cities ownership of various utilities has proved markedly successful.

Most American cities now own their own waterworks, and about one third of them own their own gas or electric light plants. A few cities own either a part or the whole of their street railways. Municipal ownership of public utilities is still in its infancy, but the movement is growing.

342. CONDITIONS OF MUNICIPAL OWNERSHIP.—Past experience indicates several mistakes to be avoided in any future consideration of the problem of municipal ownership.

The terms upon which the city purchases a utility ought not to be so severe as to discourage the future development of new utilities by private enterprise.

Public ownership is practicable only when the utility has passed the experimental stage, for governmental agencies cannot effectively carry on the experiments, nor assume the risks, so essential to the development of a new enterprise.

Any discussion of public ownership ought to include a consideration of social and political factors, as well as matters which are strictly economic.

The question of municipal ownership should be decided purely on the basis of local conditions and for particular utilities. The successful ownership of street railways in one city does not necessarily mean that a second city may be equally successful in operating this utility. Nor does the successful administration of a gas works by one city necessarily mean that the same city can effectively administer its street railways.

B. NATIONAL OWNERSHIP OF RAILROADS

343. DEVELOPMENT OF RAILROADS IN THE UNITED STATES.—The railroad history of the United States began when the Baltimore & Ohio was opened to traffic in 1830, but until the middle of the century transportation in this country was chiefly by wagon roads, rivers, and canals. After 1850 the westward expansion and the development of industry throughout the country greatly stimulated railway building. Encouraged by lavish land grants and other bounties extended by both state and Federal governments, railroad corporations flung a network of railroads across the continent. Local roads were transformed, by extension and consolidation, into great trunk lines embracing thousands of miles. From 9,021 in 1850 our railway mileage increased to 93,267 in 1880, to 193,345 in 1900, and to approximately 260,000 in 1922.

344. THE PRINCIPLE OF DECREASING COST.—While the rapid development of American railroads has had an inestimable effect upon our national prosperity, railway development has brought with it serious evils. In order to understand the nature of these evils, let us notice that with railroads, as with municipal utilities, the cost per unit of product or service declines with an increase in the number of units furnished. A railroad must maintain its roadbed, depots, and terminals whether one or an hundred trains are run, and whether freight or passenger cars run empty or full. Many of the railroad's operating expenses also go on regardless of the volume of business. Thus the cost of handling units of traffic declines as the volume of that traffic increases.

These circumstances influence rate-making in two ways. In the first place, railroads can afford to accept extra traffic at a relatively low rate because carrying extra traffic adds relatively little to the railroad's expenses. In the second place, rates in general cannot be definitely connected with the expense of carrying specific commodities, hence rates are often determined on the basis of expediency. This means that high rates are charged on valuable commodities because those commodities can pay high rates, while low rates are charged on cheap goods, because those goods cannot stand a high charge. This is called "charging what the traffic will bear."

345. EVILS ATTENDING RAILROAD DEVELOPMENT.—Since many of the expenses of the railroad go on regardless of the amount of traffic carried, railroads are constantly searching for extra business. Competition between railroads has tended to be very severe. Rate-wars have been common, because of the small cost of handling extra units of traffic. In the struggle for business, railroads once habitually offered low rates on competitive roads or lines, and then made up for this relatively unprofitable practice by charging high rates on non- competitive roads. The desire for extra business, together with the pressure exerted by trusts and other large shippers, encouraged railroads to make rates which discriminated between products, between localities, and even between individuals. The ruinous character of competition often led to monopolistic combinations which proceeded to charge the general public exorbitant rates, but which rendered poor service.

346. EARLY STATE LEGISLATION.—During the early stages of railroad development, the railroads were generally regarded as public benefactors for the reason that they aided materially in the settlement of the West. But after about 1870 the railroads began to be accused of abusing their position. A greater degree of legal control over the roads was demanded.

The first attempts at the regulation of railroad corporations were made by several of the states. For fifteen years various commonwealths tried to control the railroads through state railway commissions armed with extensive powers. These commissions eliminated some of the more glaring abuses of railroad combination, but for several reasons state regulation was relatively ineffective. The states had, of course, no authority over interstate business, and most railroad revenues were derived from this type of business. State laws regulating railroads were often declared unconstitutional by the courts. Lastly, powerful railroad corporations often succeeded in bribing state legislatures to refrain from taking action against them. Due to these influences, state regulation was generally conceded to be a failure.

347. FEDERAL LEGISLATION.—The failure of state laws effectively to control the railroads led to the enactment by Congress of the Interstate Commerce Act of 1887. This Federal act created an Interstate Commerce Commission of seven members, appointed by the President, and charged with the enforcement of the Act. The Act also prohibited discriminations, and forbade unjust and unreasonable rates. It required that railroads should make rates public, and that they should not change rates without due notice. Pooling was forbidden, that is to say, railroads apparently competing with one another were no longer to merge or pool their combined business with the understanding that each was to get a previously determined share of the joint profits. The objection to pooling was that it suppressed competition and encouraged monopoly.

In the years that followed, however, the Interstate Commerce Act checked railroad abuses very little. The machinery of the Act was so defective as to render difficult the successful prosecution of offenders. Railroad interests exerted an evil influence upon government officials who were attempting to enforce the Act. The administration of the law was also markedly impeded by the fact that the courts tended to interpret the Act of 1887 in such a way as to limit the powers of the Commission.

To a considerable extent discriminations and unnecessarily high rates continued until after the opening of the twentieth century. Then in 1903 the Elkins Act revived some of the waning powers of the Commission. Three years later (1906) the Hepburn Law increased the membership of the Commission, improved its machinery, and extended and reinforced its control over rates. In 1910 the Mann-Elkins Act strengthened the position of the Commission in several particulars.

In spite of this additional legislation, however, the rather sorry record of railroad regulation up to the time of the World War repeatedly raised the question of national ownership of railroads.

348. ARGUMENTS IN FAVOR OF NATIONAL OWNERSHIP OF RAILROADS.—The arguments in favor of national ownership of railroads are similar to those advanced in behalf of the municipal ownership of local utilities.

The failure of regulation, coupled with the social importance of the railroads, is said to render ownership imperative. Government ownership of railroads is said to have succeeded in several of the countries of Europe, notably in Prussia.

It is believed by many that government ownership would attract a high grade of public official. It is also thought that with the change to public ownership the corruption of state legislatures by railroads would cease. Since the roads would be taken out of private hands and administered as a unit by the Federal government, discriminations and other unfair practices would cease.

It is also held that under public ownership service rather than profits would become the ideal. Since profits would no longer be necessary, lower rates could be offered. Government ownership would allow the elimination of duplicating lines in competitive areas, and would permit the extension of new lines into areas not immediately profitable. Thus railroads now operated solely for private gain would become instruments of social as well as industrial progress.

349. ARGUMENTS AGAINST NATIONAL OWNERSHIP OF RAILROADS.—Opponents of national ownership maintain that the experience of Prussia and other European countries is no guide to railroad management in this country. Differences in political organization between this and European countries, for example, render unreliable the results of public ownership in Prussia and other parts of Europe.

Many opponents of government ownership contend that the elimination of private control would increase, rather than decrease, political corruption. Various political interests, they say, would bring pressure to bear in favor of low rates for their particular sections of the country.

It is often maintained that the substitution of public for private ownership would discourage personal initiative because public officials would take little genuine interest in the railroads. It is said that government administration of railroads would be marked by waste and inefficiency. This would necessitate higher rates instead of permitting rates to be reduced. The large initial cost of acquiring the roads is urged against public ownership, as is the gigantic task of administering so vast an industry.

A last important objection to public ownership is that it would cause rates to be rigid. Rates would be fixed for relatively long periods and by a supervisory agency, rather than automatically changing with business conditions as under private ownership. This rigidity would force business to adapt itself to rates, instead of allowing rates to adapt themselves to business needs.

350. GOVERNMENT CONTROL OF RAILROADS, 1917-1920.—Shortly after our entry into the World War, the congested condition of the railroads, together with the urgent need for a unified transportation system, led to a temporary abandonment of private control. On December 28, 1917, President Wilson took over the nation's railroads under powers conferred upon him by Congress. The roads were centralized under Director-General McAdoo, assisted by seven regional directors who administered the railroads in the different sections of the country.

The Act empowering the President to take over the railroads provided that such control should not extend beyond twenty-one months after the conclusion of the treaty of peace with Germany. But there has never been a well-organized movement for government ownership of railroads in this country, and when after the signing of the armistice in November, 1918, the immediate return of the roads to private control was demanded, there was little opposition. A number of plans proposing various combinations of public and private control were rejected, and on March 1, 1920, the roads were returned to their former owners.

351. RESULTS OF GOVERNMENT CONTROL DURING THE WORLD WAR.—Government control of the nation's railroads between 1917 and 1920 resulted in a number of important economies. Repair shops were coÖrdinated so as to be used more systematically and hence more economically. The consolidation of ticket offices in cities effected a substantial saving. The coÖrdination of terminals allowed a more economical use of equipment than had been possible under private control. The unification of the various railroad systems allowed a more direct routing of freight than would otherwise have been possible. There was also a reduction in some unnecessarily large managerial salaries.

On the other hand, the quality of railroad service declined under government control. The personal efficiency of many types of railroad employees also decreased. Most important of all, there was a sharp increase in both freight and passenger rates.

The period of war-time control was abnormal, hence the record of the roads under government control during this period cannot be taken as wholly indicative of what would happen under permanent government control in peace time. But it should be noted that, on the whole, the record of the Railroad Administration between 1917 and 1920 was good. That the above-mentioned economies were effected cannot be denied. Moreover, the decline in service and efficiency, as well as the increase in rates, is at least partially explained by abnormal conditions over which the Railroad Administration had no control. The winter of 1917-1918 was the most rigorous in railroad history. This circumstance, combined with the unusually heavy demands for the transportation of war equipment, helped to demoralize the service from the very beginning of the period of government control. For a number of years previous to 1917 there had been an acute shortage of box cars and other equipment, which also helps to explain the poor quality of service furnished during the war. The labor force was demoralized by the drafting for war service of many trained railroad employees. (It is claimed that certain railroad officials sought to discredit government control by hampering the administration of the roads, but this charge cannot be proved.)

352. THE TRANSPORTATION ACT OF 1920.—Government control in war time revealed the true status of the railroads as nothing else could. It was seen that up to the period of the World War Federal legislation on railroads had in some cases been too indulgent, but in other cases so severe as to work a hardship upon the roads. To pave the way for a fairer and more effective regulation of the nation's railroads, the Transportation Act of 1920 was passed. At present the railroads are privately owned, but publicly regulated by the Interstate Commerce Commission, according to the provisions of the Interstate Commerce Act of 1887, the Elkins Act of 1903, the Hepburn Law of 1906, the Mann- Elkins Act of 1910, and the Transportation Act of 1920.

353. SUMMARY OF PRESENT LEGISLATION ON RAILROADS.—At the present time all unfair discriminations are generally forbidden. But it is now recognized that under certain conditions a discrimination may be economically justified. Therefore, when the inability to levy a discriminatory rate would work a hardship upon a railroad, the Commission is authorized to suspend the rule. Pooling is likewise generally forbidden, but here again the Commission may authorize the practice at its discretion. Limitations are placed upon the power of railroads to transport commodities in which they are interested as producers.

All interstate rates are to be just and reasonable, and the Commission is empowered to say what constitutes just and reasonable rates. In order to prevent rate wars, the Commission is now empowered to fix minimum as well as maximum rates. The Act of 1920 also gives the Commission the power to establish intra-state rates, where such rates unjustly discriminate against interstate or foreign commerce. An intra-state rate, of course, is one which has to do only with freight or passenger movements which begin and end within the borders of a single state.

The Act of 1920 extended government control over the railroads in a number of important particulars. To check certain financial abuses, the Commission now has supervision over the issue of railroad securities. For the purpose of increasing the social value of the nation's railroads, the Act of 1920 instructs the Commission to plan the consolidation of existing roads into a limited number of systems. Another clause in the Act of 1920 provides that no railroad may abandon lines, build new lines, or extend old ones, without the consent of the Commission. In times of national emergency, moreover, the Commission may direct the routing of the nation's freight, without regard to the ownership of the lines involved. Lastly, the Act of 1920 made provision for a permanent arbitration board for the settlement of labor disputes in the railroad industry.

354. THE OUTLOOK.—In view of the defective character of regulatory legislation previous to 1900, government ownership of railroads did not seem unlikely. But since the acts of 1903, 1906, and 1910, and especially since the passage of the Transportation Act of 1920, there has been such high promise of efficient regulation as to minimize the movement toward government ownership. Not only are old abuses now more likely to be remedied, but the Interstate Commerce Commission is now empowered to relieve the roads of many undeserved burdens. Especially is the Commission keenly appreciative of the necessity of stabilizing the credit of the railroads. Until this is done the investing public will have little confidence in the railroad business, and the roads will continue to be inadequately financed.

Perhaps the greatest problem now before the Commission is to complete the "physical valuation" of the railroads begun in 1913. This valuation aims to discover, by investigations conducted by expert appraisers, the actual value of all railroad property in the United States at the present time. On the basis of this valuation the Commission believes that it can estimate the probable amount of invested capital which the railroads represent. After this has been done, the Commission can calculate what rates the railroads must charge in order to earn a fair dividend on their money. The completion of this physical valuation is, therefore, necessary if the Interstate Commerce Commission is to fix rates which are just and reasonable from the standpoint of the public on the one hand, and from the standpoint of the railroads on the other.

QUESTIONS ON THE TEXT

1. What is the economic basis of natural monopoly?

2. Describe the regulation of local utilities.

3. Give the chief arguments in favor of municipal ownership.

4. What arguments are advanced against municipal ownership?

5. What is the extent of municipal ownership in this country?

6. Name some of the fundamental conditions of municipal ownership.

7. Outline briefly the development of railroads in this country.

8. How does the principle of decreasing cost apply to railroads?

9. Discuss the evils resulting from railroad development.

10. Why did State regulation fail to eliminate these evils?

11. Discuss the nature and effect of the Interstate Commerce Act.

12. Give the chief arguments in favor of national ownership of railroads.

13. What are the chief arguments against this step?

14. When and why were the railroads taken over by the Government?

15. Explain clearly the nature of the results of government control of railroads.

16. Enumerate the laws under which the Interstate Commerce Commission now administers the railroads.

17. Summarize present railroad legislation with regard to

(a) discriminations,

(b) rates, and

(c) the extension of Federal control authorized under the Act of 1920.

18. What is the greatest problem now before the Commission?

REQUIRED READINGS

1. Williamson, Readings in American Democracy, chapter xxviii.

Or all of the following:

2. Ely, Outlines of Economics, chapter xxvii.

3. Fetter, Modern Economic Problems, chapters xxvii and xxx.

4. King, Regulation of Municipal Utilities, chapter i.

5. Seager, Principles of Economics, pages 419-431, and chapter xxiv.

QUESTIONS ON THE REQUIRED READINGS

1. What is meant by Transportation Economics? (Ely, page 557.)

2. Explain clearly why public utilities are natural monopolies. (Seager, pages 419-426.)

3. What is the origin of the right to regulate public utilities in the public interest? (King, page 4.)

4. Why must municipal utilities be regulated or controlled? (King, pages 11-16.)

5. What is the relation of unregulated municipal utilities to bad politics? (King, pages 17-19.)

6. What are the legal duties of corporations controlling municipal utilities? (King, page 10.)

7. What forms may municipal ownership take? (Fetter, pages 461-462.)

8. How does uniformity of product favor monopoly? (Fetter, page 463.)

9. Why did the railroads receive liberal help from state and Federal governments during the period of railroad development? (Fetter, page 413.)

10. Distinguish between local and personal discriminations. (Fetter, pages 416-417.)

11. Discuss the nature of the early state railroad commissions.(Fetter, pages 420-422.)

12. In what respects was the Interstate Commerce act amended by the legislation of 1903, 1906 and 1910? (Seager, pages 442-443.)

13. What was the nature of the Commerce Court? (Seager, page 444.)

14. What is the most convincing argument against the public ownership of the telegraph and the telephone? (Seager, page 445.)

TOPICS FOR INVESTIGATION AND REPORT

I

1. Make a list of the natural monopolies in your locality.

2. To what extent are the public utilities in your locality controlled by the (a) municipality, the (b) state, the (c) Federal government?

3. The franchise-granting power in your state.

4. The regulation of local utilities in your municipality.

5. Extent of municipal ownership in your section. If possible, visit a municipally owned utility and report upon it.

6. Interview an official of some local utility upon the desirability of municipal ownership of that utility.

7. The history of railroad development in your section.

8. Outline the more important laws enacted by your state legislature relative to railroads.

9. Service and rates in your locality during the period of government control, 1917-1920.

II

10. Regulation of local utilities through the franchise. (King, Regulation of Municipal Utilities, part ii.)

11. Regulation of local utilities through the utility commission. (King, Regulation of Municipal Utilities, part iii.)

12. Standards of service for local utilities. (Annals, vol. liii, pages 292-306.)

13. The case for municipal ownership. (King, Regulation of Municipal Utilities; Thompson, Municipal Ownership)

14. The case against municipal ownership. (King, Regulation of Municipal Utilities; Porter, Dangers of Municipal Ownership.)

15. Early development of railroads in the United States. (Coman, Industrial History of the United States, pages 232-248; Bogart, Economic History of the United States, chapters xxiv and xxv; Lessons in Community and National Life, Series C, pages 217-233.)

16. Geographical distribution of railroads. (Semple, American History and its Geographic Conditions, chapter xvii.)

17. Combinations in the railroad industry. (Lessons in Community and National Life, Series A, pages 219-224; Bogart, Economic History of the United States, chapter xxix; Johnson, American Railway Transportation, chapter iii.)

18. Rate-making. (Johnson, American Railway Transportation, chapter xx; Bullock, Elements of Economics, pages 212-217.)

19. Physical valuation of the railroads. (Annals, vol. lxiii, pages 182-190.)

20. Railroad regulation and the courts. (Johnson, American Railway Transportation, chapter xxvii.)

21. War-time control of railroads in the United States. (Annals, vol. lxxxvi, all; Dixon, War Administration of the Railways in the United States and Great Britain, part i.)

22. Report of the Interstate Commerce Commission upon the desirability of government ownership of railroads in the United States. (Cleveland and Schafer, Democracy in Reconstruction, pages 382-396.)

23. War-time control of railroads in Great Britain. (Dixon, War Administration of the Railways in the United States and Great Britain, part ii.)

24. Railroad management in England and France. (Johnson, American Railway Transportation, chapter xxiii.)

25. Railroad management in Italy and Germany. (Johnson, American Railway Transportation, chapter xxiv.)

FOR CLASSROOM DISCUSSION

26. The success with which public utilities in your community have been regulated.

27. Should the franchise-granting power in your state be still further restricted?

28. The success of municipal ownership in your locality.

29. The relation of "stock watering" or "overcapitalization" to high profits. (See Taussig, Principles of Economics, vol ii, page 385.)

30. Is public ownership of railroads more practicable under a democratic or under an autocratic form of government?