Essentials of Economic Theory Part 20

_The Case of Railroads whose Entire Routes are Parallel._--We have to consider only one more typical case in order to have before us a sufficient number to establish the general principles which govern the charges for the carrying of freight by railroads. Variations innumerable might be stated; and, indeed, the experience of the railroad system of this country affords the variations and reveals the results which follow from the conditions they create. The railroads may be strictly parallel lines, pursuing the same route and competing for local traffic as well as for through traffic. If the case we lately examined insures consolidation,--and indeed all of the cases we have stated impel the companies powerfully toward it,--this last case makes a.s.surance doubly sure. Strictly parallel railroads competing for traffic over their entire routes and neither uniting nor showing any of the approaches to union would be an impossibility. Persistent compet.i.tion would then mean reducing all charges to the level fixed by variable costs, which would leave no revenue whatever to cover fixed costs, and would send the companies into a bankruptcy from which even reorganizations could not relieve them, since they could not annihilate all the fixed costs.

_A Case of Arrested Development._--It is clear that, in the entire policy of railroads, the fact that their capacity has never been fully used plays a highly important part. It makes the distinction between fixed costs and variable ones a leading element in the adjustment of charges. With the capacity of railroads completely used, as is that of a ship which carries a full cargo at every voyage, the distinction would lose most of its importance. More business would then require an addition to every part of the plant and would thus entail new fixed costs which would have to be charged against the new business. As the traffic of any railroad grows toward its maximum, the cost which each separate addition to it entails grows larger and larger. When cars are few and are only half filled, an increment of traffic entails a very small increment of expense. When the cars are filled and new freight requires the purchase of more of them, the cost of this addition to the traffic becomes greater. When further additions to the freight carried require additions to trackage, yard room, storage room, etc., they cost far more than the earlier additions; and new increments of freight come, in the end, to cost very nearly as much per unit as the general body of the previous traffic when all outlays were charged against it. The railroad approaches the condition of the full ships referred to, in which further cargoes require further ships, with all the outlays which this implies. The distinction between different kinds of costing is gradually obliterated, and railroads steadily draw nearer to that ultimate state which other carriers more quickly approach, in which each part of the freight carried must bear its share of the total costs entailed. Long before that state is reached, however, combination ensues, and the movement of freight charges toward their static standard is arrested.

[Ill.u.s.tration: C | | | HIGHWAY | | RAILROAD | A-------------------------------B / / ____ / ___ __________/ ____/ WATER ROUTE ]

_The Standard of Freight Charges under a Regime of Monopoly._--A consolidation so complete that it would merge all rival lines under a single board of control and pool all their earnings would restore the early condition described in connection with one of our ill.u.s.trations--that of the single railroad between A and B, having only sailing vessels and wagons as rivals. It is able to charge what the traffic will bear in a simple and literal sense. The consolidated lines can, if they choose, get for each bit of carrying the difference between the value of goods at the point where they are taken and their value at the point where they are delivered. These values are approximately what they would be if no railroad existed. The carrying done by the railroad itself does not enter into the making of them.

The natural value of a commodity at A is what it costs to make it there, and the value at B is either the cost of making it at B, or that of making it at C and carrying it in wagons to B, or that of making it at A and carrying it by water to B. In any case there is a natural and simple process of fixing the costs both at A and at B, and the difference between them is the limit up to which the railroad can push its charges if it will. Where the business which furnishes the freight is not fully developed, the railroad may moderate its charges for the sake of letting it grow larger. The hope of increased traffic in the future may cause a reduction of demands in the present. We shall see what other influences may keep the charges below their possible level; but the natural difference between two local values of goods is the basis of the charge for carrying them from one point to the other. Consolidated lines, if they had as perfect a monopoly of carrying by railroad as has the single line in our ill.u.s.tration, would base their charges on this simple principle, though for a number of reasons they might not take all that the principle would allow.

_How Imperfect Consolidation Works._--Imperfect consolidation, when it follows a period of sharp compet.i.tion, has to deal with obstacles which prevent a complete carrying out of this policy. Many rates have become far lower than the rule of monopoly would make them, and there are difficulties in the way of raising them. A weak combination of parallel lines may keep its charges within bounds, partly from a fear that larger ones may afford too great an incentive to secret rate cutting and may so break up the union, and partly from a respect for what the people may do if the exactions of the railroads become too great. The more complete forms of consolidation have not the former of these dangers to fear; and if, without being restrained by the state, their charges continue moderate, it is mainly due to the fact that other lines less firmly consolidated are unable safely to make a radical advance of rates, and that this often prevents such a course in the case of lines which would otherwise be able to take it.

_Limits on the Charges of a System of strongly Consolidated Lines._--This means that where a great system of railroads occupying the whole of a vast territory is so firmly consolidated as to have a complete monopoly of carrying by rail within the area, it is still affected in indirect ways by the possible rivalry of lines altogether outside of its territory. An excessive charge on freight from Chicago to New York might induce carrying by rail from Chicago to Norfolk and thence by water to New York. It might cause grain, flour, etc., to be shipped to Europe from Southern ports rather than from those on the Atlantic coast. These cases and others do not fall under principles essentially different from those already stated, but they call for the application of the same principles in complex conditions which our study is too brief to cover. There is a supposable case in which nearly all that could be secured by any railroad connecting Chicago with the Atlantic coast, even though every line in the territory between them were the property of one corporation, would be the variable cost of carrying goods over a line running to a port on the Gulf of Mexico. Reflection will easily show how the principles already stated apply to this case and others.

_Effects of a General and Strong Consolidation._--With all the lines in this country and Canada in a strong consolidation, the advance of rates to, or well toward, the limit set by the principle of natural place value created would inevitably come unless the power of the state should in some way prevent it. The railroads would be able to get the difference between the cost of goods at A, in the ill.u.s.trative case, and the cost of making or procuring them at B without using the connecting line of railroad. When the appeal to the state is only imminent,--when the power of the government is not yet exercised, but impends over every railroad that establishes unreasonable charges,--the rates may be held in a fair degree of restraint. A wholesome respect for the _possibilities_ of lawmaking here takes the place of actual statutes. A respect for the law appears in advance of its enactment and may amount to submitting rates in an imperfect and irregular way to the approval of the state. This effect, when it is realized, is to be credited in part to laws which will never be enacted. The merely potential law--that which the people will probably demand if they are greatly provoked, but not otherwise--may be a stronger deterrent than the prospect of more moderate legislation. In general a considerable part of the economic lawmaking of the future will undoubtedly be called out by demands for action that is too violent to be taken except under great provocation. The dread of the extreme penalty insures a cautious policy in increasing charges which have been established under a transient regime of compet.i.tion. Partial monopolies adhering to rates many of which were established under the pressure of compet.i.tion--such are the railroad systems of America. The existing condition shows some of the effects of compet.i.tion which has ceased and of legislation which has not taken place. As the combinations shall become greater and stronger, the situation everywhere will become more and more akin to that which existed in a local way when a single line of railroad had no effective compet.i.tion, and the charges which the traffic would bear were fixed in the way we have described and absorbed the place value which the carrying created. It is a method which exposes the public to an extortion which, though not unlimited, is unendurably great. Consolidation, therefore, means the control of rates by the state; but it is essential that this control be exercised with due regard for the economic principles which rule in this department of industry. Thus only can there be secured the results of a natural system unperverted by monopoly.

The principles which a study of simple cases suffices to establish are as follows:--

1. Freight charges are essentially a variety of price. They express the exchange value of place utility.

2. The static standards or norms toward which these prices tend are fixed in the same way as are other static standards of value,--by a rule of cost,--though in the case of railroads the working of this rule is exceptional.

3. When carrying is done by simple means and by competing carriers, the ultimate basis of charges is the cost of the carrying; and this is estimated in the simple way in which, under perfectly free compet.i.tion, the cost of making commodities is estimated. The total outlay is charged against the total product.

4. A single railroad between one point and another, when it is not affected by the rivalry of any other railroad, can get for its service the difference between the cost of goods at the place where they are made and the cost at the point of delivery, on the supposition that they would either be made at this point or carried thither by more primitive means. Under such a partial monopoly the costs incurred by the railroad itself do not directly set the standard of its charges, but other costs do so.

5. In this case the so-called variable costs incurred by the railroad furnish a minimum limit below which its charges cannot go, but to which they tend to go in the case of traffic which cannot otherwise be secured.

6. This place value which the railroad can confer on the goods is small (1) when the cost of making the goods at their place of departure is not much less than that of making them at their place of destination, or (2) when it is not much less than the cost of obtaining them from a third point, or (3) when it is possible to carry them from the place of their origin to their destination by water or by any other cheap means of transportation.

7. Variable costs are positive additions to the total outlays previously incurred by a railroad, and they result from adding a definite amount to its previous traffic. They are less than proportionate parts of total costs, including interest, some part of operating expenses, cost of maintenance of roadway, etc.

8. The comparative smallness of the variable costs is chiefly due to the fact that the carrying capacity of railroads is only partially used. These costs become relatively larger as traffic increases, and would practically coincide with proportionate shares of total costs if the traffic should reach its absolute maximum.

9. If the place value above defined is large enough to cover the variable costs attaching to certain traffic and afford any surplus whatever, the railroad usually takes this traffic.

10. On the business which it gets the charges vary widely and, as it appears, capriciously, but they are at bottom governed by the economic principle stated--that of place value as established in ways in which the charges of the railroad itself do not figure.

11. Competing railroads tend to bring rates downward toward a minimum which is fixed by the merely variable costs of the carrying as done by one or more of the railroads themselves.

12. The compet.i.tion between railroads is arrested while they are not using their full capacity, while the merely variable costs of an increment of traffic are still abnormally low, and while many rates are so.

13. Railroads which compete for freight between terminal points are strongly impelled toward consolidation; and those which compete along their entire lines are forced to resort to it.

14. Consolidation in its more imperfect forms tends to establish rates that are abnormally high, but this tendency is somewhat checked by the danger that the combination may be broken by a desire to foster business in a section of country and by the indirect influence of lines outside of the territory controlled by the consolidated roads.

15. In its stronger and more extended forms consolidation leaves the people with no adequate safeguard against extortionate charges except as this is furnished by the intervention of the state; and this needs to be effected with an intelligent regard for the natural forces which are at work amid the seemingly capricious irregularities in the present system of charges.

_The Aim of Regulation by the State._--An aim of a government, in all of its economic policy, is to insure the best use of the national resources, and this can often be done by keeping alive free compet.i.tion. Where the rivalry of producers is active, a law of survival guarantees that the more economical method of producing an article shall displace the inferior one. When the choice lies between using a quant.i.ty of free and disposable labor in making goods in a certain market and using it in making them elsewhere and carrying them to the market, the alternative which gives society the most that it can get by any use of its productive resources is the one that is spontaneously selected.

_How an Extortionate Local Charge may sometimes be reduced without Injury to a Railroad._--A low charge for freight carried from A to B coupled with an extortionate one from A' to B might preclude making the goods at A', though they can be made there at excellent advantage and the interests of society will soon require that they be so. This situation can exist only so long as traffic is slight between A and A'

and greater between A' and B. The growth of traffic over the former section of the route will make it desirable for the railroad to raise its rate over that portion. If, under compulsion or otherwise, it reduces the rate from A' to B sufficiently to permit the production of the goods at A', it will gain a profitable traffic between A' and B at the cost of giving up a relatively unprofitable one between A and B.

[Ill.u.s.tration: A---------------------------B A'

_Variable Costs a Proper Basis for Some Charges._--It makes for general economy to pay respect to the distinction between fixed and variable costs and let much freight be carried for anything it will yield above the variable ones. If ten units of labor are required for making an article at B and only five at A, and if a railroad between these points, whose capacity is not fully utilized, can carry the article from A to B with an expenditure of two additional units of labor, then society can best get the goods for use at B by spending these seven units in the making and carrying. It would take ten units to make them at B, and to society itself there is a saving of three units from making them at A and carrying them at a special rate to B.

Till the railroad is more fully used for other purposes this source of economy will continue. Though the rates charged for this freight would bankrupt the railroad if they were applied to its entire traffic, it is best for the railroad to take this special bit of carrying at any rate exceeding the wages of the two units of labor; and for the time being this is the best way to use some of the social resources, since it gives at the point of delivery and use more goods for a given outlay than could have been had in any other way.

_Why Consumers may suffer while Particular Producers may be Favored._--It will be seen that this principle affords an inducement for making a special cla.s.sification of certain goods and carrying them for less than merchandise of a generally similar kind is carried for.

It is a policy of "making traffic" which costs little and is worth more than it costs both to the carrier and to society. This incentive for reducing charges does not operate as strongly in the case of goods carried to consumers who are forced to live on the route. They are held there by the general causes mentioned at the beginning of the preceding chapter, and must pay the tax which the railroad imposes on them. The only limit on this tax is the possibility of otherwise procuring the goods or of moving out of the territory. The ultimate possibility that population may not grow under a regime of extortion and that both freight traffic and pa.s.senger traffic may be held within small limits imposes some check on the railroad's exactions. The company may find it worth while to foster to some extent the growth of population; and to favor producers of certain goods in order to induce them to locate their establishments on its line, and the result of this may be good for society; but there is no way of securing a general good from the heavy tax on the rest of the traffic unless this has been necessary to insure the existence of the railroad itself. In that case there may be a temporary necessity for it, which will disappear as traffic grows.

_The Policy of the State in Dealing with Low Charges based on Variable Costs._--The interest of railroads which have a monopoly of their routes is to advance the rates on through traffic. We have noticed a possible case in which some equalization of charges by occasional reductions of local rates takes place. An increase of charges over long routes not made necessary by any pressure of business which overtaxes the railroad's carrying power would of course be injurious.

Moreover, carrying full loads does not const.i.tute such an overtaxing as calls for the higher rates. There are times when present supplies of cars and engines may not be able to move more freight than they do; but in that case more of them are called for. Only when the point is reached at which providing for this through traffic in addition to the local freight entails additions to the permanent plant and involves costs that exceed the return from the through business, is it justifiable, in the interest of social efficiency, to advance such charges. In preventing such an advance under other conditions a government helps to secure an approach to a natural economy and a maximum of production.

_When, in the Interest of General Productivity, a Reduction of Local Charges is called for._--We saw that carriers of a primitive kind competing with each other would put every charge, local or otherwise, on a basis of its proportionate share of total costs. The traffic as a whole would return enough to cover all the outlays, and each part of it would yield its share. This is the ideal of effectiveness for railroads, as well as for ships and wagons. The attainment of the ideal without a regulation of charges by the state is never to be expected. One feature of this normal condition is that, where no special improvements have recently been made, total returns should just equal total costs, in the sense in which terms are used in static theory--that sense in which all interest charges and all expenses of management figure among the costs. No net profit for the _entrepreneur_, but full interest for the capitalist and full wages for all varieties of labor, is the rule that gives the static measure of normal returns. If a state shall slowly reduce the charges for local freight, while holding unchanged those for through traffic,--all the while allowing the total returns of the railroads to cover what we have defined as total costs,--it will do all it can toward securing an approximation to the condition which affords the largest product of social industry. It will help to make the resources of the people do their utmost in yielding an income. Total returns covering all costs, a reduction of those charges on local traffic which have prevented industries from springing up at intermediate points between favored centers, a gradual increase of local production without any positive repression of production elsewhere--such are some features of the general change which the future should bring and which only the power of the state can make it bring.

_How the State may secure what Compet.i.tion secures in Other Fields._--In general industry the rivalry of entrepreneurs carries prices to a level fixed by costs, but in transportation the rivalry has so largely disappeared as to prevent such an outcome. The state cannot restore much of the vanished rivalry and would cause an unnatural condition if it did so. We have seen toward what an abnormal level of costs a sharp "freight war" carries rates. What the state can do is something which an instinctive judgment of the people is impelling it to do; namely, to adjust rates directly and bring them gradually toward the standard to which compet.i.tion, if it were working as it elsewhere works, would automatically bring them, namely, that at which wages and interest are fully covered. A surplus above these outlays could always be temporarily secured wherever a special economy had been effected, and the source of legitimate profit would be open to carriers as it is to producers generally. How much should be reckoned as interest depends on the question how the capital itself is estimated, and here again the instinct of the people has been correct.

It will not accept as a measure of true capital the market value of all the stocks and bonds the railroad has issued. The quotations of the market make the total values of the stocks and bonds equal a capitalization of its total earnings, and these may include a profit due to monopoly. If a state were to figure the capital in this way, and then so adjust rates as to allow ordinary interest on the sum thus computed, it would merely leave total returns as they are. It might change comparative charges, but not the sum total of all of them.

_How Capital should be Estimated._--In that static condition in which, as we have shown, capital is as productive in one subgroup as in another, the capital is first measured by the cost of the goods that, in the inception of the industry, embody it, and in static studies this cost is regarded as constant. Returns from different outlays are equalized, and a dollar invested in one kind of business then yields as much in a year as a dollar in any other. In a dynamic state the cost standard still prevails, and as the tools of production become cheaper, in terms of labor, it takes more of them to represent the same amount of capital that was originally invested. What it would at any time cost to duplicate every item in the equipment of a business measures the capital it uses. Nothing but a failure of compet.i.tion in the case of railroads prevents the application of this standard to them. Monopoly makes earnings more or less independent of sums invested and causes purchasers to buy stock at rates that are independent of costs of plant and equipment and are fixed by earnings themselves.

_The Process of Estimating Capital on the Basis of Cost._--If we undertake here to do by public authority what compet.i.tion elsewhere tends to do, we shall have to restore the standard based, not on the original cost of the railroad's substantial property, but on the cost of getting another that would be equal to it in working efficiency.

The plant is worth what it would naturally cost to duplicate it; and an average rate of interest on that sum is the natural return from it.

There are ethical claims which are ent.i.tled to respect and which preclude any sudden reduction of the value of a railroad's properties; and, moreover, the end in view can be attained in a way that will not necessarily take anything from the absolute amount which they are now worth. If the amount of dividends remains fixed, the increase in the actual value of the plant itself will bring these dividends into the proper ratio to it. The land that the companies use is becoming more valuable. Measured by what it would cost to duplicate it, it represents a larger and larger amount on the companies' inventories.

If the equipment also is enlarged as traffic grows, the entire sum on which interest and dividends are computed becomes continually larger.

If the interest and dividends earned by the plants now in existence remain fixed in absolute amount, they will become a smaller and smaller percentage of the real capital of the companies. Merely letting railroads earn the amount that they do at present would bring the net incomes after some years to the same rate--the same percentage of invested capital--that the income from other capital represents.

New plants and enlargements of old ones should be allowed to earn enough to furnish an incentive for providing them as fast as the needs of the public require it.

_How Insuring a Fixed Amount of Total Earnings would affect the Rates charged for Freight._--It goes without saying that the general increase of traffic, while the freight charges remain the same, increases the net earnings of the carrying companies. Therefore the policy of keeping the net earnings at a fixed total amount would mean a reduction of rates for freight and pa.s.senger service. We do not here raise the question how much reduction will be required for the purpose in view--that of transferring to the people at large whatever now const.i.tutes a genuine monopoly profit. In the case of some lines there is, it is safe to say, no such profit, and it will be impossible to tell how much of it elsewhere exists till some careful appraisal of plants and equipments, on the basis of the cost of duplicating them, shall have been made. What we need to know is that, by the aid of such an appraisal, the state can, if it will, secure in the department of carrying the result which is automatically secured elsewhere, namely, the prevalence of charges which afford normal returns on invested capital as well as wages for every kind of labor.

_Elements of the Problem not included in a merely Economic Study._--It will not fail to occur to any reader that in making the present study of railroads a very general and purely economic one we leave out of account some facts of great importance. We take no account of corruption within the corporations which do the carrying, nor of corruption in the relation between them and the officials of the state. Stockholders within the corporation are likely to have their interests betrayed by those who are appointed to take charge of them, and citizens of the state are likely to have their greater interests betrayed, in a like manner, by their appointed custodians. We cannot here discuss the various plans by which directors plunder their own corporations, nor the ways in which public officials betray the people. All of these abuses are disturbing influences in the economic system; and all of them interfere with the adjustment which gives the highest productive efficiency, and contribute a full share toward putting the social order in danger. All are, however, so obviously criminal, if they are judged by the spirit of the law,--not to say by the letter of it,--that it is better to leave the discussion of the mode of suppressing them to legal and political science.

_A Practical Mode of Insuring an Approach to Normal Rates for Transportation._--When compet.i.tion rules, it enlarges the supply of a dear article till the price of it is normal, and it increases the capital in a profitable business till its earnings become so. In the case of railroads this does not automatically take place, but the result of it all--adequate service and normal charges for it--can be directly secured by the state. Charges that have been made reasonable by compet.i.tion may be left as they are, and those that are disproportionately high may be gradually lowered. The growth of traffic may be trusted to keep the total earnings of the companies'

present plants at the amount at which they now stand, in spite of these reductions of rates; and enlargements of the plants may be permitted to earn further sums which will attract capital and keep the service abreast of the public need. All this will require expert skill of a very high order. For the purpose of the present work it is enough to say that such a course as this is the only one which will insure in transportation the results which compet.i.tion elsewhere yields. It will secure both rates and service which the civil law calls "reasonable"

and economic law calls "natural."

CHAPTER XXV

ORGANIZATION OF LABOR

What an economist wishes first to know concerning the organization of labor is whether it is a natural phenomenon which should be welcomed and left to itself. Does it help to establish wages on the basis of the productivity of labor, and does it do it without much reducing that productivity? We shall find that it works both well and ill in these particulars and needs close study and careful regulation.

What laborers themselves ask concerning the organization of men of their cla.s.s is simply what power it has to raise their own wages; and we shall shortly find that it has a certain power when it does not invoke the principle of monopoly and a much larger power when it does so. We shall find that the benefit from mere organization may be extended to the great majority of laborers, while that which depends on monopoly is confined to relatively few and involves an injury to the remainder.

_The Static Standard of Wages of Unorganized Labor._--In that static state toward which society is always tending, and in which the normal standard of wages is completely realized, men are supposed to get all that they produce. The law of marginal productivity of labor works, as it were, _in vacuo_, and gives an ideally perfect result. Every unit of labor receives what a marginal unit produces.