Understand Data to Effectively Regulate Railroad Rates

Railroads occupy a unique space in the American economy. As privately owned and operated enterprises, they face the same pressures as any other company.

However, as an enterprise tied to the public good, railroads are also more directly connected to – and shaped by – government oversight and regulation.

One of the government entities in charge of this oversight is the Surface Transportation Board, which ensures railroad rates increase only at a pace with the broader economy’s performance.

STB’s oversight of railroad operations includes monitoring a metric known as “revenue adequacy,” stating railroad companies should not generate returns on capital investment beyond what they need to get by.

Given the industry’s competitive pressures, the facing caps on revenue at the hands of the government should raise concerns.

Those concerns will become significantly more pressing if the proposal currently before the STB gains steam. The proposal would empower the STB to cap railroad rates once they’ve reached “revenue adequacy.”

Two University of Chicago economists recently published a paper detailing the proposition’s problems, and explains how the proposal threatens to put railroad companies at a severe disadvantage by discouraging – or even punishing – strong financial performances.

Since revenue adequacy thresholds don’t apply to railroads’ capital investment competitors, the proposal would cause railroads to be less appealing to investors who are, understandably, motivated by returns.

A responsible investor should make decisions based on returns. Such considerations are at the root of a business mindset. Any regulatory mechanism meant to reduce the reasonable returns of a crucial sector is misguided. With demand expected to increase in the coming years, the barrier to private investment will make it difficult for railroads to grow, upgrade, and keep the nation’s freight moving efficiently.

The paper’s authors are also concerned with the proposal’s definition of “revenue adequacy.” Analysis of past financial performance, they say, will not accurately predict the revenue levels needed to sustain future performance. Citing statements made by two other prominent economists, the paper notes: “there is no way in which one can look at accounting rates of return and infer anything about relative economic profitability … Economists (and others) who believe that analysis of accounting rates of return will tell them much (if they can only overcome the various definitional problems which separate economists and accountants) are deluding themselves.”

Rather than looking to the past to build their definitions, the STB should look forward – and should carefully consider the impacts of enacting a regressive constraint on one of the nation’s most crucial industries.

The University of Chicago also reviewed comparable S&P 500 companies’ performance from 2006 to 2018, which shows the financial performance of railroads falls well below average – hardly a sign of financial over-performance or greed.

As the STB continues its important work, it must utilize relevant and compelling data.

In truth, the latest revenue adequacy proposal falls short. Competition has yielded an efficient, affordable, and reliable railroad system. The STB must resist misguided calls to move the industry backward.

Originally published on Dakota War College