The Cato Review of Business & Government
Thomas Gale Moore is a member of the President's Council
of Economic Advisers. The author's
views do not necessarily reflect those of the council.
Our economic system is built on the transportation of goods, services, and people. The fact that transportation represents 3.3 percent of our national income understates the vital importance of that sector to our economy and our well-being. All trade includes the movement of products, services, or labor. A good case could be made for the proposition that had transportation not improved significantly over the last 200 years, our economy would still be relatively primitive and our standard of living much lower.
Improvements in transportation widen and deepen markets. Whereas in the nineteenth century each town of any size had its own shoe factory, ironmonger, and beer brewer, today large automated plants service major portions of the country form a single location. Without improvements in transportation, such gains in economies of scale would have been impossible. Oranges were expensive luxuries 100 years ago; fruits and vegetables were only available from local sources and thus unavailable most of the year.
Since the founding of the first states, governments have assumed a major role in providing for transportation. Today our government builds, subsidizes, and regulates much of the infrastructure on which transportation relies. This article addresses the role of the federal government in financing the regulating transportation-including the airline, trucking, railroad, pipeline, and shipping industries-and presents a set of desirable reforms in transportation policy.
The Role of Government
There are several economic rationales given for a significant government role in the transportation industries. None of these, however, comes close to being a universal truth. Studies in recent years have found that only rarely do the economics of transportation justify the degree of government intervention that we observe.
Traffic Management. A fair portion of government regulation of transportation simply provides for the smooth flow of traffic. Devices like stoplights and lane markings are supplemented with extensive regulations that set forth the rules of the road: drive on the right, pass on the left, yield right-of-way, and so forth. The Federal Aviation Administration (FAA) issues such rules for air traffic; the Coast Guard does the same for shipping traffic. While traffic-management rules are often presented as safety measures, they are more than that: they minimize interference among users in order to make the most efficient use of the physical infrastructure. They are needed in every mode of transportation.
Infrastructure. The government has an important role in providing the infrastructure for transportation as well as in managing traffic. While it is possible to have the infrastructure furnished by the private sector various levels of government have traditionally financed, at least in part, the basic investments in transportation facilities. Private toll roads, for example, have been built and are under consideration in some parts of the United States, yet for many highways charging explicit tolls would increase user costs significantly. Even ignoring the increased congestion that a toll booth would create, the cost of manning and collecting the tolls would be horrendous. The technology, however, has been recently developed that would permit an inexpensive monitoring of traffic that could significantly reduce highway congestion at peak hours. Nevertheless, virtually all highways, roads, and city streets are built by governments, often using funds raised from fuel taxes.
For similar reasons governments have usually funded harbor projects, river dredging, and canal building. (Governments also fund such projects because they arc politically attractive local projects.) With the exception of canal building, which has involved some significant private efforts in the past, almost all financing is public-usually through the federal government. For less obvious reasons governments have been the chief owners, builders, and operators of airports used by commercial aviation. Private airports once serviced commercial aviation and do service general aviation, but currently within the United States all commercial airports are owned or operated by local authorities.
The railroad industry is the only major form of transportation responsible for its own infrastructure. The distinction may be misleading, however. The construction of railroads in the nineteenth century was so heavily subsidized that the system was overbuilt to the point that rail rates did not adequately cover capital costs. As a consequence the railroad industry has been either marginally profitable or unprofitable for most of its history, with periodic waves of bankruptcies.
A major factor accounting for government involvement in transportation infrastructure is the necessity of providing rights-of-way. Through eminent domain the state has the legal right to acquire property for public use; it is considerably more costly for a private firm or individual to purchase rights-of-way. Most railroads were built through grants of public land and therefore never faced the right-of-way problem. Since rivers and harbors in the United States are not privately owned, private provision of water infrastructure is uneconomical.
Economic regulation of the transportation industries in this country is 101 years old. In 1887 the Interstate Commerce Commission was created to regulate railroad rates. Initially ICC supervision was intended to reduce the monopoly power of railroads over certain traffic from small towns. The railroads supported regulation to reduce pressures to lower rates in highly competitive markets. With the advent of motor vehicles in the early part of the twentieth century, regulation was extended, first by states and ultimately by the federal government, to motor carriers. This extension of regulation to an inherently competitive sector was designed to protect the profits and business of the railroad industry. Subsequently water carriers, airfreight, and air passenger transportation were brought under federal control.
Each of these industries was subject to restrictions on rates, entry, exit, and profits. The result turned out to be massively inefficient. Costs were inflated, routing was inappropriate, rates were excessive, and yet the firms often failed to earn the profits that would be expected in a cartelized environment. Some of the "benefits" of regulation were siphoned off to organized labor. Some were simply wasted in nonprice competition or in inefficient rules and, at least for trucking firms, some were capitalized into the value of the operating certificates granted by the ICC.
As the inefficiencies were recognized, pressure grew to deregulate these industries. In fact, as part of a worldwide movement toward freer markets, deregulation has become an important idea, not only within the United States but also in Europe and Asia-even in non-market countries. In the United Slates this has taken the form of eliminating economic regulation of the airline industry (including air freight) and significantly reducing regulation of motor carriers, buses, and railroads. The results have been excellent.
Issues in the 1980s
Airlines. Among the industries granted new freedoms in the late 1970s, the airline industry has been the most thoroughly examined. Study after study has documented the benefits that passengers have received from the removal of most controls in 1978 and the elimination of the Civil Aeronautics Board in 1982. A 1986 Brookings Institution study by Clifford Winston and Stephen Morrison concluded that airline passengers gained about $11.5 billion annually (in 1988 dollars) from deregulation. Deregulation has permitted airlines to become more efficient. Load factors have improved; more passengers are carried on typical long-haul flights. The result is that airlines arc able to charge less and be as profitable as they were under regulation.
Safety, which has steadily improved since the advent of commercial aviation, has continued to advance. Comparing accident figures eight years prior to deregulation and eight years following it, for example, it can be seen that the number of accidents has fallen by nearly one-third and the number of fatalities per 100,000 flight hours by one-half.
The airline industry has expanded since deregulation. Employment grew by more than one-third from 1977 to 1986. Wages of airline workers appear to have kept up with wages in the rest of the economy over this period. And, contrary to the fears of many, air service to small communities has grown rather than contracted.
Alongside employment growth in the industry, productivity has increased sharply. On the long-haul routes airlines are utilizing larger aircraft with more seats. The hub-and-spoke system has led to a more efficient use of both planes and personnel. Overall, airlines increased their productivity by 7 percent from 1976 to 1983, in spite of the sharp increase in fuel prices. Over the same period, non-U.S. carriers suffered about a 40 percent reduction in productivity.
Studies indicate that airline profits have been helped by deregulation. If gains to passengers are added to the airlines' increased profits, the total benefit from airline deregulation is about $15 billion per year.
Railroads. Deregulation of the railroad industry has provided large benefits to shippers as well as to the railroads themselves. The Staggers Act, passed in 1980, freed nearly two-thirds of the railroads' traffic from government supervision. The industry has been granted more freedom to abandon unprofitable routes and to merge weak railroads. As a consequence rail shipping costs as measured by revenue per ton-mile, which had remained virtually constant in real terms from 1970 to 1981, fell nearly 20 percent in real terms over the following four years. Although not all commodities have enjoyed lower rail rates, Federal Railroad Administration rate indices show declines for farm products, chemicals, primary metals, and transportation equipment between 1980 and 1985. And while the coal industry has complained that railroads have increased charges, at least in some uncompetitive markets, the average revenue per ton for coal shipments has been approximately constant since partial deregulation.
Railroad workers have been able to maintain their wage rates but have faced a considerable contraction in employment. Annual compensation for employees of the major railroads rose 20 percent in real terms in the decade of the 1970s, and continued to escalate at about the same rate for the next five years. Under the new freedom given the railroads by the Staggers Act, the high cost of labor led to a one-third cut in employment in the five years from 1980 to 1985. The net result was a sharp increase in labor productivity, as the railroads continued to carry as much freight with less labor.
Trucking. In 1980 Congress also partially deregulated the motor carrier industry. Shippers have benefited strongly from this legislation. Revenue per ton for truckloads, an indicator of shipping rates, fell 22 percent from 1979-1980 to 1986, and revenue per ton for less-than-truckload shipments declined 6 percent from 1983 to 1986. A survey of shippers indicates that service quality has improved on average as well. In seven major dimensions the shippers rated the less regulated service as better than or as good as the service prior to partial deregulation. Studies done for the Department of Transportation show that service to small communities has been maintained or even improved since trucking firms were given more freedom.
Two groups lost from trucking deregulation: the owners of the certificates of public convenience and necessity, and the members of the Teamsters Union. Both had profited significantly from the suppression of competition under ICC regulation. The ICC grants of operating authority were bought and sold for hundreds of thousands or even millions of dollars, reflecting the value of the monopoly franchise. Truck drivers and their helpers earned wages that I estimated, in 1978, to be 50 percent above the competitive level.
With the advent of partial deregulation and the ICC's liberal policies in granting new certificates of public convenience and necessity came a surge of entrants: the number of firms with operating rights has almost doubled. Consequently, the value of the operating lights has fallen to close to zero.
In addition many of the new entrants have not been unionized, which has put considerable competitive pressure on existing trucking firms to reduce their labor costs. With nonunion wages typically 25 to 35 percent below teamster wages, the percent of motor carrier workers that were unionized fell from around 60 percent in the late 1970s to 28 percent by 1985. Moreover, union contract wages, which had increased 20 percent in real terms in the 1 970s, fell 12 percent in the five years after the 1980 act. In a 1987 study published in the Journal of Political Economy, Professor Nancy L. Rose of MIT's Sloan School of Management calculated that the aggregate wage loss was between $990 million and $1.8 billion (in 1986 dollars).
Oil and Gas Pipelines. Oil pipelines have been regulated since the early l900s when the Standard Oil Company was accused of using them to consolidate market power over production and retail markets. Fortunately entry and exit from the business have never been regulated. As a result, competition has coexisted with regulation and prevented the misallocation of resources caused by regulation in other industries. Individual oil producers or refiners who might have been captive shippers bought into the pipeline system to ensure access to this vital transportation link. Transportation of oil by ship, barge, and truck provided competitive alternatives in the majority of markets.
Recent court eases have put pressure on the Federal Energy Regulatory Commission (FERC) to regulate oil pipeline rates more strictly. An investigation by the Antitrust Division of the U.S. Department of Justice, however, found few examples of harmful market power. The Reagan administration has proposed deregulating most oil pipelines and keeping a simple price cap on the remainder.
Unlike oil, natural gas cannot be transported economically by water or by truck, so natural monopolies in the pipeline network may be more common for gas than for oil. Since 1954 when the U.S. Supreme Court ruled in Phillips Petroleum Company v. Wisconsin that wellhead prices needed to he controlled, the regulation of rates for gas pipelines has been tangled with the regulation of gas itself. In the last 10 years some progress has been made in deregulating gas. At the same time FERC has been looking for ways to bring more competition to bear on gas transportation.
Maritime Shipping. National security is a common rationale used for providing subsidies to the merchant marine. However, there is little economic reason for government involvement. The subsidy takes two forms: The Jones Act requires that all domestic shipping use U.S. ships with U.S. crews. Because of this requirement, rates are elevated well above competitive levels. In addition the federal government has provided construction subsidies for U.S. flagged ships engaged in foreign trade. Ships which receive the construction subsidies, however, are not permitted to engage in domestic trade. The Reagan administration has allowed some ships to repay this construction subsidy, thus recovering the cash and improving competitive conditions in domestic trade at the same time. Nevertheless, the whole industry remains inefficient and expensive both for shippers and for taxpayers.
Issues for the 1990s
Probably the most important issues for the 1 990s deal with ensuring an appropriate infrastructure for airways, maintaining and extending the deregulation of surface transportation and airlines, and finding a workable and more limited system for regulating oil and gas pipelines.
Infrastructure. The aspect of air travel that has received the most criticism since deregulation is congestion and delays. Part of the problem was the 1981 air-traffic controllers' strike and their subsequent firing just at the time air travel was growing rapidly after deregulation. It took several years for the FAA to rebuild its staff; even today there are fewer controllers than before the strike.
Airline deregulation contributed strongly to growth in air travel. As a result airports, aircraft, and airspace have become more congested. Inevitably this has led to more delays and a perception that safety is eroding. Numerous studies have looked at the safety question, and failed to find any harm to safety from deregulation or the growth in traffic. Yet the congestion is real. Certainly the number of passengers per plane has gone up. Moreover, the growth of the hub-and-spoke system, and the need to transfer passengers within a short time period from one flight to another, has led to airports that at peak times rival the streets of Manhattan during lunch hour.
Quick, easy, and cheap air travel also has led to considerable peaking problems in the airline industry. Business people prefer to take short flights first thing in the morning and longer flights late in the afternoon. A great many business flights are one-day round trips. Rush-hour traffic leads to congestion everywhere, including in the sky. But this congestion is not always inefficient. To eliminate rush-hour delays and congestion on our highways would require the construction of a considerably larger road system, one that would remain virtually unused much of the time. The same is true for airways. To eliminate all congestion at airports, in aircraft, and in the airways would be costly and inefficient. It would require the construction of considerable excess capacity that would be idle much of the time.
Congestion can result from inadequate capacity or, more important, from the inefficient utilization of existing capacity. In the case of air travel and highway transportation, there is no mechanism to allocate usage to non-peak times except the queue. That is, only if congestion and delays become so costly to users that they voluntarily shift to the non-peak period is there any rationing of scarce peak facilities.
For air travel, however, it is far easier to adopt a price system for rationing capacity. Two elements of air travel are under priced: the FAA does not charge directly for the use of its services, nor does it charge different prices for peak and off-peak periods. Airports do charge landing fees but, in the main, these tariffs are low and invariant with time. A few airports do impose a surcharge for peak use, but even in these cases the surcharge is small.
The FAA collects a ticket tax that is considered to be a user fee and that is deposited in the Airport and Airway Trust Fund. Since this tax is collected from all passengers as a percentage of the price of their ticket, it is unrelated to time of use or costs imposed on the air system. Thus the FAA charges nothing directly for the use of the air-traffic control system no matter how congested it is. If the system cannot handle more traffic at peak periods, the expectation is that the FAA will spend the funds to expand capacity.
In a more rational system the FAA would charge for use of the air-traffic control system. This simple change would reduce use by general aviation. Many pilots of small planes would elect to utilize small private or municipal airports that do not offer FAA-manned towers. Moreover, charging premiums for use of the system during congested times would shift some commercial or general aviation flights to other, less crowded periods. Not only would this save resources, but also it would make the system safer by reducing congestion.
A good method of introducing rational pricing in the air-traffic control system would be to shift this system from the public sector into the private sector. In some parts of the world private companies operate air-traffic control towers, as they have in the United States in the past and do at a number of smaller airports even today. A useful first step might be to allow airports to opt out of the FAA tower system and trust fund, and in return receive a portion of the ticket tax generated at that airport. The airport would be free to charge for the use of the tower and would be responsible for constructing and maintaining its own landing facilities. The airport would hire its own air-traffic controllers and provide its own control equipment.
Such an approach would naturally lead to a more rational scheme of landing fees. At most airports landing fees arc ridiculously low. For example, a small plane can land at Washington's National Airport during the peak morning hours for $6-less than it costs to pat-k a car for the day. Some airports, like those under the jurisdiction of the New York Port Authority, have experimented with surcharges for peak periods with good results. Even in these cases, however, surcharges arc comparatively low and do little to affect commercial aviation scheduling decisions.
Extending and Maintaining Deregulation
There arc considerable pressures to reverse, at least in part, some of deregulation's successes. Coal companies, power producers, and grain shippers have lobbied to limit rail price increases for "captive shippers." Such shippers are those that have no good alternative for moving their goods by other than a single railroad. Under the Staggers Act, the ICC is charged with interpreting and defining "captive shippers." A number of these bulk commodity shippers claim that the ICC has failed to protect them from a railroad monopoly.
Actually, the issue revolves around which business interest is going to keep any high earnings derived from favorable location or special factors of production. For instance, if a coal company, either because of its location or because of the quality of its coal, is in a position to earn profits in excess of a normal return on its investment, a monopoly carrier could charge so much that the coal mine earned only a normal profit while the railroad kept the extra revenue. From an outsider's point of view there would be little reason to favor the stockholders of the coal firm over the stockholders of the railroad company. If a railroad does charge excessively, this simply induces the shipper to search for alternatives.
It is also worth keeping in mind that the railroads have been financially weak for decades. Only with the advent of the Staggers Act has the industry moved away from bankruptcy. Tinkering with the Staggers Act therefore should be avoided.
While there arc no visible efforts now underway to rewrite the Motor Carrier Act, there is a danger that with pro-regulatory commissioners the policies currently being followed on entry and pricing might be reversed. Reregulation could be reimposed by the ICC on its own. Consequently, it is important that the next administration work to remove the remaining controls on trucking. Currently these controls only add to the paper work and serve no useful function. Occasionally the commission forces a trucking firm that gives a discount to a shipper to recapture the discount, a result that increases uncertainty and reduces competition. There is no economic justification for continued regulation of this inherently competitive industry.
Reregulation of the airline industry is also a possibility that must be opposed vigorously. The greatest danger is that the FAA will be given more power to control landing slots at airports and be induced to use such power to limit entry into particular markets. Once entry is limited, price will naturally have to be controlled to protect consumers. Thus it is imperative that the FAA's control over landing slots, which is now exercised in a few congested markets, be limited or eliminated. Placing restrictions on the number of take-offs and landings would be a move in precisely the wrong direction.
Legislative action is needed to deregulate oil pipelines, and a bill to deregulate natural gas should also liberalize the regulation of gas pipelines. Absent legislative action, FERC should be encouraged to continue its experiments with greater competition in the industries it regulates.
The guiding principle for the next administration in transportation policy
should be to foster market forces. Economic regulation should be limited or
eliminated. More use of the market will provide gains to users of the transportation
system and to our economy, while protecting the gains already achieved through
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