October 14, 2020 marks the 40th anniversary of the enactment of the Staggers Rail Act – the law that largely deregulated economic dealings within the freight rail sector. So far removed, the anniversary may seem irrelevant, but the opposite is true: rail deregulation serves as an important case study on matters related to competition, markets, rate regulation and capitalism writ large.
Please join us for a discussion to analyze the rail regulatory experience and to see if there are any lessons to be learned from efforts to impose “common carrier” utility regulations on other sectors in the American economy. Covered topics will include a summary of rail deregulation, how it continues to be challenged and why core tenets of the Staggers Act are especially relevant for salient discussions related to ratemaking and due process under the Fifth Amendment.
George S. Ford, Chief Economist, Phoenix Center for Advanced Legal & Economic Public Policy Studies
Timothy Strafford, Associate General Counsel and Corporate Secretary, Association of American Railroads
Moderator: Lawrence Spiwak, President, Phoenix Center for Advanced Legal & Economic Public Policy Studies
This call is open to the public and press. Dial 888-752-3232 to access the call.
Dean Reuter: Welcome to Teleforum, a podcast of The Federalist Society's practice groups. I’m Dean Reuter, Vice President, General Counsel, and Director of Practice Groups at The Federalist Society. For exclusive access to live recordings of practice group teleforum calls, become a Federalist Society member today at fedsoc.org.
Nick Marr: Welcome to The Federalist Society’s Teleforum conference call, as this afternoon—not just the afternoon—October 14, 2020, we’re discussing the “Staggers Act Turning 40: Lessons Learned from Railroad Regulation.” I’m Nick Marr. I’m Assistant Director of Practice Groups at The Federalist Society.
As always, please note that expressions of opinion on today’s call are those of our experts.
Now, we’ve got a couple of panelists here, but I’m just going to introduce our moderator this afternoon, Lawrence Spiwak. He’s the president of the Phoenix Center for Advanced Legal & Economic Public Policy Studies. Larry’s going to introduce our other panelists, and as a note for the audience, we’ll be looking for audience questions towards the end of the call, so be thinking of those as you’re going along and have those in mind for when we get to that portion of the call. All right. Well, thanks for being with us here today, Larry. I’ll give the floor up to you now.
Lawrence Spiwak: Thanks a lot, Nick. And welcome everybody. We appreciate you joining us. The title of today’s Teleforum is “The Staggers Act Turns Forty: Lessons Learned from Railroad Regulation.” And any time a law that turns 40 years old, it’s always good to look at it, but what’s interesting, at least, to me, as we think about the Staggers Act, and we look at the current environment in which we are in, there are -- and this is why I think looking at the Staggers Act is an excellent time to do so right now.
There’s a lot of talk about imposing public utility regulation across many sectors. As Federal Trade Commissioner, Christine Wilson, recently wrote in a law review, and she said this publicly in a couple of speeches, “Heavy sectoral regulation is back in vogue.” And what’s interesting is that a lot of people are pointing to rail regulation as a great example of fantastic regulation of which we should emulate.
So now that we’ve got the Staggers Act turning 40, why don’t we look at railway regulations and see how that’s worked out, what’s been good, and what’s been bad. To talk about that, we have a really outstanding panel. First, we are very lucky to have Tim Strafford, who’s the Associate General Counsel and Corporate Secretary of the Association of American Railroads, so he really is one of our country’s leading expert in railroad regulation.
And we are also joined by the Phoenix Center Chief Economist, Dr. George Ford. And George has done also some work in the railroad field and in terms of investment and financial health, so, hopefully, we’ll have a really good discussion today and see what we can find out. So let’s start, I think, probably for those who are unfamiliar with the Staggers Act, with the background of the Staggers Act, when it was passed, how it came to be, the history of it. And, again, as we have Tim as one of the experts on it. Tim, if you wouldn’t mind starting us off with a little bit of history, if you wouldn’t mind.
Timothy Strafford: Sure. I’d be happy too. Thanks, Larry. It’s interesting—as you made reference to comments about rail regulation—I think for those of you who don’t toil in this field—and I pretty much know everybody who does, so there aren’t that many of us—it’s easy to fall into a thumbnail sketch of regulation of robber barons of the 19th century and in regulations, and I guess everything worked out fine.
And, in some ways, the regulatory paradigm we have today is a strong one, but it took a lot of pain and work to get there. The Interstate Commerce Commission was the very first regulatory commission created back in 1877, and it was regulating an industry, a new technology, that revolutionized commerce in the United States. And, over time, the regulation of railroads didn’t necessarily reflect the changing dynamics, the changing economy, changing technologies.
Regulation tends to favor stability over everything else in favor of the status quo and even entrenched interest. And so, over the years, as technology changed, and markets changed, and the automobile was invented, interstate trucking came along; interstate highway came along. The competitive landscape for railroads changed dramatically, and regulation didn’t necessarily. You had a regulatory regime that protected competitors and not competition.
You can go and look at some old ICC decisions. It’s pretty striking and very different than the way we think about competition today as the commission was focused on protecting weak competitors and protecting what they call the inherent advantages of each mode, and that cutthroat competition was to be discouraged, and railroads shouldn’t be undercutting traffic that moved by barge, and things like that.
Rates and services were regulated. Railroads lived in a collective ratemaking world. Railroads, under the offices of ICC, had to get together and collectively set rates through things called rate bureaus, and the ICC regulated minimum and maximum rates. Railroads also had severe constraints on them on the cost side.
If a railroad wanted to discontinue or abandon service on a line, that was not profitable, it was very difficult to do so. It had to get permission from the agency, and standards very much favored the preservation of service. There was also a common carrier obligation to provide passenger service, whether or not those services made money. And so, as you can imagine, all of those cumulative effects, or that sort of heavy-handed regulation on top of increasing competition from a more flexible competitor, led the railroad industry to a state of financial ruin.
Before Enron, the largest corporate bankruptcy in the United States, was the Penn Central Railroad. During the ‘70s, most railroads in the northeast were in bankruptcy, and actually more than 20 percent of all of the rail-marginalized states would be operated by railroads in bankruptcy. Railroads couldn’t earn returns on their investment.
By the ‘70s, they were less than three percent, and some years down close to two percent. And, as a result of regulation and other things, the market share for intercity freight fell dramatically. It was an untenable state of affairs. And we’re talking about the Staggers Act today, and that was a culmination in 1980 of a deregulatory effort, but it wasn’t a singular lighting bolt. There were a number of incremental steps to get there.
First, the Passenger Rail Act of 1970 were leading carriers of the obligation to provide passenger service. The Regional Rail Reorganization Act and the Railroad Revitalization and Regulatory Reform Act, 1976, affectionately referred to as the “3R” and “4R” Acts, were all incremental steps to dismantle this regulatory regime. And, at that stage, the nation was at this fork in the road, or a switch in the railroad, to decide whether they were going to go down the road of subsidizing freight rail, a nationalization paradigm, or to deregulate and to allow markets and demand for service to dictate outcomes in the rail industry.
Fortunately, they picked the later. The Stagger of Rail Act in 1980 chose to partially deregulate the rail industry, allowed market forces to work, and recognize really that the railroads operate in competitive transportation markets. And, as such, demand for service and competition should determine outcomes, and, in those rare instances, where there is not effective competition, regulation may be appropriate, but that regulation should mimic competitive outcomes. And the results have been striking. I’m sure we’ll talk about that in a second.
But, just in terms of specifics of what Staggers did, it put an end to this collective ratemaking. Almost all circumstances, there’s very limited [inaudible 10:00] immunity for certain interline where railroads have to connect to complete a movement. It legalized contracts between railroads and their customers. Customers could enter into confidential rail contracts and lock in service and other standards.
It recognized the need for railroads to earn adequate revenues and required the agency to regulate in a way that promoted revenue adequacy—almost a regulation of the regulator. It required showings of market dominance before rates could be regulated. That meaning that it had to be showing that there was no effective competition before the agency would intervene in rate matters. It allowed and actually directed the agency to be gracious and practical to exempt traffic from regulation, whether it was competition.
And, finally, it allowed railroads to abandon unprofitable lines and thus rationalize their system. I’ve been talking for a while now, and I feel like I should probably pause and let Larry chime in, but that’s the landscape that the Staggers changed. It was really a decisive shift towards markets and market outcomes.
Lawrence Spiwak: Well, let me just ask you a follow-up question, Tim, and then I want to get to George because I think this is a really important point about the history of rail regulations, and prior to the Staggers Act—and correct me if I’m wrong—but really the overregulation of the industry really led to almost the industry’s financial collapse, and so it was a major congressional policy to ensure the financial health of the railroad.
Again, we had these massive bankruptcies that were going on all over the place, and just talk about that a little bit because then we can get to George’s analysis with the financial health of the industry, which I think is important. But just elaborate on that point just real quick if you wouldn’t mind.
Timothy Strafford: Yeah. That’s exactly right. So you had an industry that was struggling to attract capital. Investors were leaving in droves, and rail companies had to find even alternate businesses to generate returns. And the deregulatory effort really focused on the notion that railroads needed to be regulated in a way that allowed them to attract capital in order to allow them to invest in their private networks. You can imagine a company that’s earning a two percent return on investment does not have the financial capital to invest for growth, certainly.
They didn’t even have capital to make necessary maintenance spends. The state of the rail network in the United States declined. The term entered the Railroad Lexicon standing derailment—the notion that a railcar would fall over, standing still, just because of the condition of the track. So I don’t think it’s too extreme to say that the nation’s rail system was facing a potential crisis, and that focused the attention of policymakers on the need to allow investment in the network.
Lawrence Spiwak: So then it’s interesting again about this regulation that unlike your standard ratemaking, which is [inaudible 13:56] -- just a reasonable thing for me to get into that. But the financial health really was a very motivating factor, and would you say that that pervades -- it’s a key goal in railroad regulations to make sure, particularly, as its critical infrastructure, that this is I think somewhat unique in a ratemaking statute, but that is a key congressional objective here. Would that be safe to say that?
Timothy Strafford: Yeah. That’s absolutely true. It’s explicit in the statute, both in the policy section, the rail transportation policy, as well as the various rate provisions that the agency must consider the revenue adequacy of the rail carrier. And, actually, the agency is actually directed to regulate in a way to promote adequate revenues.
Lawrence Spiwak: I think that’s a very important thing that -- again going back to “Was rail regulation this model that we want to look to in that overregulation actually harmed” -- we had bankruptcies. And I think that’s an important so this is constant -- and that goes to just how the STB, as you said a moment ago, Service Transportation Board—let me throw in the acronym there, correct—how it does it.
So let me then turn here to George. You did a paper last December on infrastructure investment in the railroad industry. Could you walk us through what you found there, George, if you wouldn’t mind?
George S. Ford: Yeah. Well, that was a big issue, as we just discussed, as the investment in railroad infrastructure and how that had become a serious problem under the regulatory regime and the increase in competition, which combined to put great financial stress on the railroads.
And so we have in the policy the revenue adequacy, which is basically regulating the regulators, what I like to call it, where the acts of regulation can be so aggressive as to threaten the returns of the railroad companies, at least, to the extent that revenue is adequate to cover expenses and to maintain investment levels.
What I wanted to do is to see—because the argument has been made—of course, that increased regulation would threaten investment in the sector. So I took some data on investment in the industry, and also data on its return on investment, and its cost of capital, and then we could see how the relationship between the health of the sector, and health of the railroad business, and how revenues were impacted by its revenue. The regulations that have been talked about recently would have -- rate regulation would cut revenues.
And so I used revenues as the determinant of investment. And what you find, as you might think, that revenues and investment are related to each other, not just correlated with each other, but this was a time series model vector autoregression, where we could actually quantify the impact of changes in revenue on investment, and found a statistically significant and a positive relationship between the two, and, in fact, that the marginal relationship is pretty close to the average relationship in the industry.
So if you look at investment per dollar revenue, that’s pretty close to what the marginal impact is as well. The paper also has some analysis of the history of the return in the industry relative to just cost of capital using data put together by the STB. And we see really only in most recent years as the return on investment approach, the cost of capital, and, in some years, it has exceeded, but it’s a highly variable series.
And I think part of the reason you hear some talk about reregulating the industry is that the return has finally come back to a—what we might describe—as a competitive return, and the fact that that threshold has been met, at least, in the sense you can measure that with accounting data, has I think made some people feel confident about reregulating the industry. Regulators regulate. That’s what they do.
And I think that the STB [audio cuts out 19:27] searching around for something to do, and I think part of that’s related to return, just not -- I wouldn’t call it stable, but certainly the healthier -- the sector that they have now has made them feel a little more comfortable about intervening. But I don’t -- I think if you look at the data that the industry is not in a situation of earning excessive returns that would justify intervention.
Lawrence Spiwak: Thanks, George. And that brings us to the segue into our next part of the discussion, which is, as we’ve just discussed, the purpose of the Staggers Act is ostensibly to lead to deregulation of the rail industry, but I think one of the lessons that -- if the law of regulation holds true, that even when one tries to deregulate, there is going to be inevitably regulatory creep. And we’ve certainly seen that at the Surface Transportation Board. And I think it’s important to recognize and discuss what they’re trying to do.
Because, again, if one is holding out rail regulations as a model, then, one, we have the issue of regulatory creep, which I just mentioned. But this is one of the things that I find exceedingly frustrating. Just my background is I got my start doing electric utility rate cases because I like to joke. I’m not proud of my ratemaking background, but I have one. Tim obviously spends his life doing rate cases over at the STB, and George has been involved in rate cases.
And what I think a lot of people miss, when they talk about rate regulation, is that regulation just isn’t -- when the government sets the price, you just can’t do so in a vacuum. You immediately bring in the due process and the taking provisions of the Fifth Amendment. You cannot escape that.
The regulations, when you have tariffs and that kind of stuff, is to protect as much the regulated as it is to govern the conduct of the regulator, and what’s been interesting, to me, is that the regulatory creep, at the STB, where you had a lot of folks essentially try and bypass that and take short cuts. And I think that raises a lot of very significant due process concerns. And so I wanted to talk about that a little bit with folks on the call.
There’s been two -- I’m sure there are a couple of other ones that Tim could probably talk about, but the two that struck me—and I’ve done some writing on this, and we’ll get to both—is one is called switched access or reciprocal access, and the other one is what they call Final Offer Rate Review. So let’s start with what they call reciprocal access. Reciprocal access is essentially where they would mandate access at a regulated price, and the Staggers Act is very clear that they never wanted to have a switched access mechanism as just as a normal way of doing business. Again, it was supposed to be deregulatory.
They had a provision in there that you could have switched access if it was shown to have some sort of -- to remedy a specific anti-competitive harm, but I guess at the end of the Obama administration, they issued a notice of proposed rulemaking, which from my understanding—and Tim correct me—is still sitting there during the Trump administration that they would essentially force switched access and change the anti-competitive standard to a more general standard to get around the statute. So, Tim, why don’t you talk about that for a second, real quick, and then we can get into the law and economics of that?
Timothy Strafford: Sure. And I’d be happy to, and just I’ll try to stay at a pretty high level. [inaudible 23:56] the weeds pretty quickly. Yeah, so just the notion of reciprocal switching is a railroad serves a facility and then switches a car to somebody else to complete the long-haul transportation, and it’s referred to as reciprocal switching because railroads tend to do this for each other—the commercial arrangements where market conditions make that in both parties’ interest.
There is a provision of the statute that allows the agency to order switching in certain circumstances, and there is both rulemaking and ICC precedent that established the rules of the road for when the agency was going to intervene and force a railroad that serves a plant to hand over that traffic to a competitor. As Larry says, that standard has been an anti-competitive one—that is the agency would order a railroad to turn over the traffic after a showing of competitive abuse. And it’s not something that’s been used at the agency.
There’s a theme running through some of the activities at the STB that if a remedy has not been used, that indicates a problem, and that, therefore, they need to then change the rules. And so, as Larry says, at the end of the Obama administration, they came out with a notice of proposed rulemaking, which would set different standards for when switching would be ordered and would remove that competitive abuse requirement. AAR filed comments in that proceeding, and obviously opposed it, and it has been dormant since then.
I do think it illustrates a fundamental question of, when is it appropriate for government to intervene in markets and what are the right circumstances to trigger dictating to a railroad what services that they provide? And, keep in mind, that switching a rail car is a labor-intensive activity. There’s physical work to attach a locomotive, move cars, use the right facilities to move that car around. You can’t just do a K-turn in the parking lot. There’s work to do that.
And, essentially, there is inefficiencies every time a rail car is handled, so the most efficient and most cost-effective way to move a rail car is to move it from origin destination and to handle it as few times as possible. And so when is it necessary for the government to step in and order that type of inefficient behavior? And so I think we made a compelling case that that should be a very rare instance.
Lawrence Spiwak: Let me turn it over to George and ask that. One of the things that the STB said is by simply getting rid of an anti-competitive problem, it seems, to me, that if you don’t have to demonstrate a market failure before intervening in the market -- if there’s no market [inaudible 27:29] remedy, then what’s the point of regulation? And they also say, “Well, look at all the mergers that have happened,” but didn’t they approve all the mergers in the first place? Does this make sense from the economist point of view of when do we regulate and when do we not regulate?
George S. Ford: Well, I think you have to, as you mentioned earlier, respect the complexity of regulating correctly, particularly, when you’re regulating price. I think demonstrating some sort of failure, some market failure, that requires intervention, it should be required in pretty much any case. That can get really complicated when you’re dealing with multiple products and firms running the cargo along different routes and prices varying in complex ways sometimes about how do you define the relevant set, relevant vector of prices that are problematic and what are the cost. Those are very, very complicated questions.
And then overriding the whole thing is this revenue adequacy constraint, which I think really is probably the most sensible way to approach the industry if the -- with multi-product firms competing, about the only result that economics can point to is that competitive firms will earn economic return. You can’t really say a whole lot about individual prices sometimes. So picking and choosing a price, and along one route or for a particular cargo, misses the point, I think, in regulating the multi-product firm.
So I think that’s a big problem. I think much of what you read that the STB has written about this, and what other people say about it, comes from that idea that we don’t really have a good way of doing this, and so we’re going to do it anyway. I think that’s almost certainly a recipe for disaster, particularly, with reciprocal switching because you’ve -- as Tim mentioned, you’re going to introduce inefficiencies.
We had the same thing in telecommunications with the unbundling regime and trying to manually remove physical plan from its connections to move it around and plug it into something else, which has just turned out to be horribly inefficient, not to mention the fact that they just couldn’t be done fast enough to really have a viable competitive scenario resulting from it.
You have to respect, I think, the difficulty of figuring out where you might want to regulate, but if it’s difficult to figure out where you might want to regulate, it’s going to be really, really difficult to regulate correctly. And I think that’s really going to be the hurdle, and you may want to regulate, and I think some people certainly do, and there are shippers who are complaining about rights as they will.
Any time you have a regulatory body, there’s going to be somebody complaining to it trying to get something from them that there’s going to be this attempt or desire to serve a constituency or just feel like you’re doing something good. But, as the more complex the problem looks, and if you’re trying to avoid that complexity, it is highly likely that the regulation is going to be very inefficient and cause a lot of side effect.
Lawrence Spiwak: Let me throw this -- following up on that, let me throw this question out to both of you. It seems, to me, that there is ratemaking provisions in the Staggers Act to be used, but yet here’s a way I think where the regulator is looking for something to do or essentially trying to short circuit that process with a very thin veil. Doesn’t that present some sort of danger where we just start reinventing the statute or ignoring the provisions that Congress put in there? Again, the rate statutes are there primarily to ensure the government conduct of the regulator, but they’re there to protect the due process rights of the regulated. Tim, what do you think about that?
Timothy Strafford: Yeah. I think any effort to circumvent the protections of a statute, in the ratemaking world, by ordering certain service is going to be problematic. I think the question of reciprocal switching is – again, when you’re thinking about the fundamental role of the agency, is it to remedy market failures and to punish anti-competitive conduct and thereby promote competition in the market place or is it some sort of affirmative responsibility to create competition where it doesn’t exist.
And, in the rail world, we’ve got a number of different things that make that notion of creating competition extremely complicated. One is the really high fixed costs of wanting a railroad. So after companies put tracks in the ground to enter a facility or enter a market to turn around and then turn that over to a competitor presents a lot of potential problems. And then also a myopic view of competition. George mentioned the multi-product firm.
You’ve got railroads providing freight transportation service, but the competitive landscape is not limited to railroads, right? There’s obviously truck competition. There is barge competition. Railroads are one piece of a global logistics network, and then there’s also competitive forces in the world. Products that can be substituted, and shipments that can move from other locations in direct competitive forces. So, myopically, looking at one plant and deciding that you’re going to put your thumb on the scale to force one railroad to turn over traffic to another is going to create ripple effects throughout the network and cause bad results.
Lawrence Spiwak: All right. Great. Thanks, guys. Okay. Well, then that brings me, then, to the second issue which is this issue -- it’s a concept that the STB has introduced, called final offer rate review, which to oversimplify—and I’ll let Tim explain—but it’s imposing “baseball-style” arbitration for ratemaking. In full disclosure, I did a piece for The Federalist Society review. You can get it on the FedSoc’s webpage, entitled “Ensuring Due Process at the Surface Transportation Board,” and I will get into this discussion in a minute where – I read this thing, and it just smacked of one due process violation after another. And so, Tim, why don’t you explain what that rulemaking, what their proposal is essentially to do, and then we’ll take off from there.
Timothy Strafford: Sure. Maybe, it’d be helpful if I took a step back to it and just talk about the rate regulation regime at the STB and then how 4R fits in or doesn’t fit in with that. So coming out of Staggers in the early ‘80s, the ICC was struggling to articulate a standard for what constitutes a reasonable rate. We talked about the due process requirements adjusting reasonable rates as well as the requirements that Congress put on the agency with revenue adequacy and instructions to allow competition and demand for service to regulate rates.
So it was struggling to find a way to set a standard, and, in 1985, they came out with a decision called Coal Rate Guidelines, and despite the name, it applies to all traffic. And they established four different constraints on railroad pricing. The most notable of those is the Stand-Alone-Cost test. But, essentially, they said there would be four constraints on pricing. One would be a management efficiency constraint that customers shouldn’t pay for inefficiencies of management. One was a Stand-Alone-Cost constraint. That is, rail carriers should not charge more than a hypothetical efficient entrant to the market would charge if there were no buyers to entry and then a revenue adequacy constraint, which was not defined, but a notion that some or all of a differential above competitive prices should be constrained if our railroad were to achieve long-term revenue adequacy.
The fourth constraint was phasing. That is, a large rate increase could be phased in over time. Of those constraints, the Stand-Alone-Cost test was really the one used by litigants at the agency, and a case law developed over time, enhanced by rulemaking to flush out how a complainant would show what a market entrant would charge to carry the traffic, and any other traffic grouped together, over the facility’s necessary surrogate.
As you can imagine, that’s a difficult thing to do. Market’s are complex. Railroads are complex. And to understand the facilities necessary to serve traffic, a fair amount of evidence has to be put into record. Because an independent commission, the ICC and the board, tended to take a balls-and-strikes approach to evidence rather than putting out exactly what should be shown. Parties were sort of free to develop their own cases. That led to pretty protracted and expensive litigation.
And so, over the years, the agency has been struggling with simplified and expedited ways to set rates. Over the years, they’ve come up with two simplifications, a simplified Stand-Alone-Cost test, which is essentially taking various shortcuts to get at the cost to provide service, and what they call a Three-Benchmark Test, which is really a rate comparison using data that the agency collects about revenues, and variable cost, and comparing the complained about traffic to a benchmark group of similar traffic.
Again, the agency has opined that they’re not seeing enough cases, that Stand-Alone-Cost is expensive to bring, and they’ve had very few of these simplified cases, so they want to do something else. They’ve proposed Final Offer of Rate Review, which, as Larry says, is akin to “baseball-style” arbitration in that the agency has supposed that parties would offer their best offers, and then the agency would, then, pick among the two and look for the maximum lawful rate.
And those are both rulemaking. We have participated in that proceeding, as well, opposing that proposal. At a very high level, it proposes a number of questions and problems, not least of which it’s skips an important question, which is the paradigm that the STB operates is a complaint-driven one. That is a complainant brings a rate case to the agency and bears a burden of proof of showing that rate is unreasonable, and FORR would take this notion of—I’m not even sure how to phrase it—that everything is potentially unreasonable. And one side comes up with an offer, and the other side just comes out with an offer, and the agency will judge it based on either its existing standards or under standards and evidence that parties cook up in this litigation. There are other problems associated with timing. There’s very limited time for defendants to reply, and so it’s problematic on a variety of levels.
Lawrence Spiwak: Yeah. It seems, to me, again, just in this effort to make bringing -- it’s funny. You said that we’re not seeing a lot of cases, so that’s the first signal to me that a regulator is searching for purpose. But there are a couple of things that strike me about this. Basic ratemaking is that regulators, they usually have great latitude in choosing the methodology that they can bring. It could be total element long-run incremental cost, rate of return, price gap, whatever you want, but litigants need to know the rules of the road going in.
Tell me what the methodology is, and that’s it. The Supreme Court has held -- you got to do that. But, yet, under this proposal it’s one side could use one methodology, and the other side could make methodology, and then like, “Well, we’ll figure that out later.” That seems to just smack of just a huge due process problem, to me, among others. What do you think about that, Tim?
Timothy Strafford: Yeah. I agree. If you take a step back and think about a legal regime where you don’t know the outcome—you don’t even know the rule until after the case is decided—it’s obviously problematic. It is impossible for a company to conform its behavior to comply with the law if they don’t know the test that’s going to be applied at the back end.
Lawrence Spiwak: Yeah. And along somewhat of lines, it’s the APA says you got to have a hearing. How do you have a hearing if it’s just “I’ll submit an offer and have a nice day.”
Timothy Strafford: Right.
Lawrence Spiwak: Yeah. George, having been an economist in rate cases, how do you prep for something like that, how do you even get prepared?
George S. Ford: Oh, it’s hard to say until you know more about how the process would proceed. I suspect the way it would go, from a legal perspective, given the due process concerns, at least, I would hope, is that you would have to come in and demonstrate that your offer is a legal one, which means you’re going to have to use the existing methodologies and not some new one, or you might be using the methodology, but you certainly have to demonstrate that it would be compatible with the old, so it means you’re going to have to the old too. But I don’t see how -- I see some legal risk of a regulatory agency saying, “We got two offers, and we took one of them, but we don’t have an extensive record to demonstrate that this is a legal rate” would be very – that sounds, to me, like a train wreck waiting to happen.
Lawrence Spiwak: Pardon the pun.
George S. Ford: Pardon the pun. But, yeah, I don’t -- it’s just hard to say until you do it, but I think what you have to end up doing is do what you would’ve done without it because you’re going to have to demonstrate that this satisfies a legal rate. You can’t just say I think it’s $1. You’re going to have to prove that that satisfies revenue adequacy, or Stand-Alone-Cost test, or whatever it is that has been established, is legitimate.
So I don’t know if it really changes a whole lot in the end or even reduces the burden on the parties. In fact, if anything, it probably increased the burden on the parties because not only do they have to demonstrate that it satisfies what is a known legal standard, but I’ve got to produce some new analysis as well.
So it’s one of those things you look at it and think this is a -- baseball arbitration is one of those ideas that people throw around a lot in regulatory space, primarily, because it gets the -- they’re trying to get the regulator out of it for the most part—the regulatory process out of it.
But when you start really thinking about applying it, it runs into a lot of problems, which is why you don’t see more of it. Only if you’re really -- the regulator has a great deal of flexibility in how it sets rates would you be able to use it, which is why it’s just not done all that often.
Lawrence Spiwak: All right. Well, on the remaining minutes we have, I want to wrap this up, and if we have time, open it up to a couple of questions, but let’s bring back to what the purpose of the panel is, and that is, are there lessons to be learned from 40 years of the Staggers Act? Has it worked, do we see -- even with the best efforts of deregulation, will the inevitability unless you actually -- a lot of people say about regulation, the only way is you got to take a vampire approach to it, drive a heart through it, kill it, otherwise, it will come back. What have we learned? So, Tim, let’s start with you. What do you think?
Timothy Strafford: Well, I think we’ve learned a number of things. First of all, looking back, even beyond the 40 years of Staggers, we’ve learned that heavy-handed regulation tends to distort outcomes and is a poor tool to use in markets that are innovating, and changing, and evolving.
I think in the Staggers Act, you see a wisdom in recognizing that markets are efficient and lead to good outcomes. We’ve seen a number of just tremendous results in the 40 years after Staggers. Railroads productivity has soared. Rates measured in the aggregate, but over time have declined. Railroads have gained market share, intercity freight. Railroads have been free to invest in their private networks and done so in big numbers. There have been huge increases in safety as railroads had the capital to invest in their networks and to invest in facilities.
You see tremendous strides in safety, and you see a dynamic shift in the industry. A lot of the regulatory talk focuses on the number of Class I railroads, and you mentioned mergers. But there is an entire industry of shortline railroads that was created after Staggers, leading to innovation and other good things. So I think we see a paradigm that’s been wildly successful, and so we have to be vigilant going forward to make sure those gains are kept and progressed and that we don’t see backsliding into some of the bad old days.
Lawrence Spiwak: Thanks, Tim. And, George, give us the economist perspective on this.
George S. Ford: Well, I mean, regulation is -- [inaudible 49:30] regulation is for monopolies. And I don’t think you can argue that the rail industry is a monopoly in transportation. There may be particular routes and things that rail is superior at handling, but you’re starting to get into small pieces of a large business, and you have to wonder whether or not having regulatory intervention, in those markets, is worthwhile, particularly, when -- maybe those markets that help ensure the revenue adequacy for the company as a whole.
I think that the thing to do, at some point, when you have an industry that has moved on from a state of monopoly to competition is that you really have to start thinking about curbing the regulatory authority significantly. We’ve had to do that in railroads already. I think the condition of competitive conditions have only gotten stronger over time.
So it may be time again to curb regulatory authority in the railroad business rather than increase it as some people proposed, mainly, because if you have a regulator, there are going to be people coming in and ask it to do things, and they’re going to want—some of them at least—are going to want to be active, and you just have to decide it may be time to severely curtail the ability of the regulator to act that way.
I know there are certainly things in the railroad business that may need some oversight, and even the railroad industry itself may prefer to have somebody there to help coordinate parts of the business, but I don’t see any evidence in the return data on revenue adequacy data that would suggest it’s time to start regulating the railroad business. I think it’s a situation that’s finally gotten to some sort of financial stability, and if you start regulating it again, I think you’re going to end up with a lot of trouble.
Lawrence Spiwak: All right. All right. Great. Thanks. Well, let’s see if we have -- in the five minutes we have left on the hour, let’s see if we have any questions. Nick, do we have any questions at all?
Nick Marr: Okay. Let’s go to it now. No one’s on yet, Larry, so it might be -- we only have a couple of minutes left, but I’ll give you a chance for any remarks you’ve got in the meantime in case we get one, then we’ll go to it. But, otherwise, we’ll wrap up.
Lawrence Spiwak: I think we will. To use the old provision, we’re bringing the train right in on time, which is always a good thing. Well, listen, I want to thank our guests, Tim Strafford, George Ford. I know I learned a lot. I thought this was an excellent discussion, and I’d like to thank The Federalist Society for hosting that, and with that, we are adjourned. Thank you very much for joining us.
Dean Reuter: Thank you for listening to this episode of Teleforum, a podcast of The Federalist Society’s practice groups. For more information about The Federalist Society, the practice groups, and to become a Federalist Society member, please visit our website at fedsoc.org.