MARKET AND SOCIAL INVESTMENT AND DISINVESTMENT IN RAILROAD BRANCH LINES: EVALUATION PROGEDUIES AND DECISION IRITERIA SiSSEMPJI'IM FOR I'I-IE DEGREE OF PH. Iii. MICHIGAN STATE UNIVERSITY MR9 W mm 197% hem .— . __ Ifllllllllllzlllfllflllllwl, 313m 3333! 2, 33w £13213? ‘8 ,5 This is to certify that the thesis entitled MARKET AND SOCIAL INVESTMENT AND DISINVES'I'IVIENT IN RAILROAD BRANCH LDJES: EVALUATION PROCEDURES AND DECISION CRITERIA presented by Marc Anton Johnson has been accepted towards fulfillment of the requirements for Doctoral degree in Agricultural Economics Major professor Date“ 5/9/75 0-7639 O 'n ¥”"~.‘E “k fr "‘ s 4‘§¢#.. ABSTRACT IMARKET AND SOCIAL INVESTMENT AND DISINVESTMENT IN RAILROAD BRANCH LINES: EVALUATION PROCEDURES AND DECISION CRITERIA By Marc Anton Johnson Collapse of the Penn Central Transportation Company and subsequent massive railroad line abandonment proposals have triggered unprecedented attention to railroad capital shortage problems developing for more than half a century. Recent federal policy actions, outlined in the Regional Rail Reorganization Act of 1973, have shifted a portion of the capital burden on lightly traveled branch lines to local communities and users of service. Railroad companies have new opportunities to evaluate branch line enterprises on the basis of market criteria. States and local com— munities have new responsibilities for public investment to continue railroad services with related nonmarket attributes. This research is approached to fulfill two missions. One mission is to deve10p a framework for extended research on the role of various economic participants in structuring an active transportation policy for lightly traveled railroad branch lines. The second mission is to contrib- ute to solution of the immediate problem of state governments, that of determining which lines to subsidize under provisions of the Regional Rail Reorganization Act. Specific purposes of this research are to determine railroad freight transportation market characteristics and to develop decision criteria and evaluation procedures for market and social investment and disinvestment in railroad branch lines. Marc Anton Johnson The market bound to supply of branch line service is developed assuming railroad firms with existing facilities and long term profit maximizing objectives, with no administered restraints and no responsi- bility for external effects of resource use. A railroad investment plan- ning model is developed incorporating a stock-flow railroad production function and acquisition and salvage alternatives for rail roadway capa- city. Assuming constant railroad rates, application of the Kulm-Tucker theorem provides necessary and sufficient conditions for Optimal firm investment and dis investment in small roadway segments . When the present value of future net revenue generated at a terminal station is less than or equal to the associated value in liquidation, the line will be sold to another entrepreneur or dismantled. When the latter value exceeds the former, a subsidy equal to the difference becomes necessary to encour- age voluntary continuation of service. A procedure is developed to evalu- ate net revenues and liquidation values on particular line segments . Preliminary application of the abandonment criterion is made to twenty-one Michigan line segments under ICC abandonment application from 1968 to 1972. Results suggest that railroads tend to seek abandonment not when opportunity losses appear, but only after operating deficits occur, revealing a tendency to maintain investments in rail roamay for periods extending beyond financial health of individual lines. The assumption of predetermined railroad rates is relaxed to allow market conditions to influence railroad pricing policies. Conditions for local railroad price discrimination and collective user subsidy are devel- oped and a rudimentary measure of revenue enhancement potential is de- signed to test the power of pricing policy in maintaining local branch operations . f, Transportation. k-- Marc Anton Johnson Consideration of the market bound of demand is limited to developing statistical experience with hedonic transportation demand estimation. A model of derived demand for railroad freight service explicitly treats railroad and motor carrier service quality variables. Derived railroad service demand becomes a function of product price, production cost and effective prices of railroad and motor carrier services. Effective transport prices are defined as published rates plus other implicit costs associated with consuming modal services. Empirical demand models are constructed to measure the influence of service quality variables upon total annual quantity of railroad service demanded and upon modal selection probability (modal split), holding in- fluences of firm and shipment characteristics constant. Quality vari- ables are selected on the basis of transportation market studies to control specification error; quality variables include speed, delay in equipment delivery, damage in transit and freight rates of rail and motor modes, and service reliability of railroads. Specification error tests based. upon BLUS residuals reveal the log-linear functional form to be superior to the linear form for railroad service demand functions. The logit- linear form of modal selection probability functions is revealed to provide consistent estimates. Demand and modal selection probability estimates are made for outbound grain shipments and inbound fertilizer and feed shipments made by Michigan grain elevators and farm stores. . Data are supplied from the Michigan Freight Transportation Survey con- ducted by the author for the Michigan Department of State Highways and Demand estimation supports previous evidence that comodity groups are differentially affected by service quality variables. Results also Marc Anton Johnson support the contention that service quality affects traffic volumes upon which abandonment decisions are based. However, the magnitude of influ- ence appears:mudh less than that suggested.by market research and testi- mony before ICC abandonment hearings. The social bound to provision of branch line service encompasses both.market recognized and external benefits and cost of investment. Legislative authorization for states and local communities to subsidize unprofitable lines limits the social bound to Pareto equilibria. Where discounted net operating revenues plus collectible external values exceed line liquidation value, branch line service lies within the social bound. Seven external effects of branch line abandonment are considered within a broad temporal and geographic frame. anmonetary impact indicators are developed for effects of line abandonment upon employment, fuel usage and highway service life. .Also considered are impacts upon rents to local properties, consumer prices, the environment and latent consumers of service. Incidence of net effects suggests that local evaluation of public participation would tend to bias willingness to subsidize in excess of net social gains. Decision criteria and evaluation procedures are applied to a two county area of central Michigan with the purpose of demonstrating use of these tools in branch line analysis. The area selected harbors representa- tive intermodal and intramodal interactions of service availability with a complete highway system and two railroad lines of different companies. Revenue enhancement from local price discrimination is seen to potentially retrieve some marginal links from deficit. Opportunities to consolidate traffic on other company lines or to divert traffic to other stations of the abandoning company, depress the viability of individual rail links. MARKET AND SOCIAL INVESTMENT AND DISINVES'IMENT IN RAILROAD BRANCH LINES: EVALUATION PROCEDURES AND DECISION CRITERIA By Marc Anton Johnson A DISSERTATION Submitted to Michigan State University in partial fulfillment of the requirements for the degree of IDCTOR OF PHILOSOPHY Department of Agricultural Economics 1975 ‘1') (C )9 Copyright by MARC ANTON JOHNSON 1975 A jewel for my family ii ACIG‘JOWIEDQIIENT S The author wishes to express his gratitude to several persons who have made significant contributions to this work. The thesis guidance committee was composed of Professors James D. Shaffer, chairman, William J. Haley, George K. Dike, A. Allan Sclmrid and Bruce Allen. Professors Shaffer and Haley provided guidance throughout the project and made very helpful suggestions for improvement of earlier drafts. Three agents of state government facilitated data collection and added much to the author's understanding of railroad branch line problems facing the state. For nearly one year, the author worked part-time within the Railroad Planning Section of the Michigan Department of State Highways and Transportation. Mr. Edgerton W. Bailey, manager of the Sec- tion, provided a valued acquaintance with the day to day administrative and political environment within which procedures, such as those developed here, are applied. Mr. Porter L. Barnett, transportation specialist, Michigan Department of Agriculture and Mr. Clarence E. Magoon, manager of the Railroad Section, Michigan Public Service Commission, also pro- vided valuable assistance and insight. The author also wishes to thank Mr. J. Michael Patrick for help with data collection and Mrs. Linda Kay and Mrs. Diane Hutchinson for typing aid. The author is grateful for financial assistance provided by the Michi- gan Agricultural Experiment Station and the Department of Agricultural Economics of the Michigan State University throughout his study program. iii TABLE OF CONTENTS Q-lAPTER I. SUBSIDIZING RAILROAD LINES: AN ANALYTICAL GAP 1 CHAPTER II. THE EVOLVING ECONOMIC AND INSTITUTIONAL ENVIRONMENT OF RAILROADING 6 The Railroad Capital Shortage Problem 6 A Half Century of Line Abandonments 20 Pmperty Rights and Railroading Resources 24 The Regional Rail Reorganization Act of 1973 31 CHAPTER III. THE MARKET BOUND -- SUPPLY 34 Multiple Outputs 35 Inputs and Cost Relationships 38 Increasing and Decreasing Average Cost 39 Resource Durability and Cost 42 Production and Investment 48 Investnent-Disinvesunent Criteria S4 The Bound of Market Supply 65 Operationalizing the Abandonment Criterion 67 The Power of Pricing Policy 77 CHAPTERIV. THEMARKETBOUND -- DEMAND 96 Derived Demand for Transportation 103 Empirical Demand Models 113 Data and Model Quality 120 Regression Results 136 Outbound Grain Shipment: Index Form 137 Outbound Grain Shipment: Linear Form 141 Outbound Grain Shipment: Logit Form 143 Inbound Fertilizer Shipment 146 Inbound Peed Shipment 150 Sumary 153 iv CHAPTER V. THE SOCIAL BOUND Externality Private Collective and Public Investment Criteria The Externality Account Employment Effects Economic Rents to Fixed Facilities Consumer Price Effects Abandonment and Energy Environmental Impact Traffic Diversion and Highway Life Option Demand Summary CHAPTER VI. APPLYING MARKET AND SOCIAL BOUND MEASURBIENTS: A CASE STUDY Economic and Transportation Base Studies Productive Resource Base Railroad Stock Highway Stock Estimating Market Values and Private Subsidy Potential Line Liquidation Value Estimating Discounted Future Net Revenues and Required Subsidies Price Discrimination and Collective User Action Traffic Consolidation and Diversion Summary of Market Valuation Procedures -- A Case Estimating Non-market Effects Employment Effects Abandonment and Energy Sumnary CHAPTER VII. CONCLUSIONS FOR POLICY PLANNING AND REMMENDED RESEARCH EXTENSIONS Conclusions for Policy Planning Recomended Research Extensions APPENDIX A. The Michigan Freight Transportation Survey BIBLIOGRAPHY 157 158 168 173 175 178 180 181 183 185 197 201 203 205 206 209 212 215 216 220 234 239 244 248 249 252 254 256 257 261 266 270 LIST OF TABLES TABLE 1. Standing Freight Car Capacity for the United States: 1960-1973 TABLE 2. Expenditures for Capital Improvements by U. S. Railroads: 1960-1973 TABLE 3. System and State Operating Ratios for Michigan Line-Haul Railroads: 1968-1972 TABLE 4. Applications for Certificates of Public Convenience and Necessity to Abandon Railroad Lines in the United States, 1921-1973 TABLE 5. Applications for Certificates of Public Convenience and Necessity for New Line Extensions in the United States, 1921-1973 TABLE 6. Estimates for Gross Material Salvage Value and Removal Cost for 'IWenty-Three Abandonment Applications Tendered for Michigan Rail Lines, 1968-1972 TABLE 7. Estimates of Net Material Salvage Value for the Mean Length of Twenty-Three Line Segments Under Abandonment Application, 1968-1972 TABLE 8. Estimates of Normal Annual Maintenance Cost for Twenty Michigan Rail Lines Under Abandonment Application, 1968-1972 TABLE 9. Estimated Annual Subsidies Necessary to Maintain Wenty- One Rail Segments Under Abandonment Application, 1968-1972 TABLE 10. Transportation Modal Characteristics Recognized and Evaluated by TWelve Michigan Shipping and Receiving Firms TABLE 11. Results of Specification Error Tests: Outbound Ship- ments TABLE 12. Results of Specification Error Tests: Inbound Ship- ments TABLE 13. Results of Specification Error Tests: Outbound Modal Selection Probability vi 10 11 13 21 22 72 73 74 78 124 131 133 134 TABLE 14. Regression Results of the Quality-Demand Relationship in Index Functional Form: Outbound Grain Movements 138 TABLE 15. Correlation Coefficients for Highly Related Variables for Outbound Grain Shipments 139 TABLE 16. Levels of Significance of Student's t-Statistics for Coefficients of Three Potentially Important Rail Service Demand Determinants: Index Form of Outbound Grain Quality-Demand Function 141 TABLE 17. Regression Results of the Quality-Demand Relationship in Linear Functional Form: Outbound Grain Movements 142 TABLE 18. Regression Results of the Modal Selection Probability Relationship: Outbormd Grain Movements 144 TABLE 19. Regression Results of Quality-Demand and Modal Selec- tion Probability Relationships: Inbound Fertilizer Movements 147 TABLE 20. Regression Results of Quality-Demand and Modal Selec- tion Probability Relationships: Inbound Feed Movements 151 TABLE 21. Summary of Commercial Traffic Distribution 189 TABLE 22. Vehicle Type Distribution and Average Daily Volume on Two Michigan Highways 191 TABLE 23. Calculating Current Traffic Load for U. S. 27 Under Three Assumed Traffic Growth Rates, 1973 Base Year 195 TABLE 24. Calculating Diverted and Total Traffic load For U. S. 27 Under Three Assumed Growth Rates, 1973 Base Year 196 TABLE 25. Nonagricultural Bnployment Distribution in Clinton and Ionia Counties, Michigan 1959-1972 208 TABLE 26. Calculation of Line Liquidation Values: Grand Trunk Western from Owosso to Lowell, Michigan 217 TABLE 27. Calculation of Line Liquidation Values: Chesapeake and Ohio from Grand Ledge to Ionia, Michigan 218 TABLE 28. Procedure for Estimating Discounted Net Revenue Attribu- table to Railroad Branch Lines: An Example 221 TABLE 29. Discounted Growth Factors for Future Traffic Generations in Clinton and Ionia Counties, Michigan 227 TABLE 30. Discounted Net Operating Revenues , Surpluses and Deficits on a Railroad Line: Grand Trunk Western 229 vii TABLE 31. Discounted Net Operating Revenues, Surpluses and Deficits on a Railroad Line: Chesapeake and Ohio TABLE 32. Maximum Potential Revenue Enhancement on Two Example Branch Lines TABLE 33. Effects of Traffic Diversion and Consolidation on Market Evaluation of a Branch Line: Grand Trunk Western from St. Johns to Lowell, Michigan TABLE 34. Market Evaluation of a 42.9 Mile Grand Trunk Western Line From St. Johns to Lowell, Michigan: Stationary Traffic Assuned TABLE 35. Immediate Local Job loss Resulting from Railroad Line Abandonments in Clinton and Ionia Counties TABLE 36. Effects of Abandonment Upon Annual Fuel Usage: Grand Trunk Western From St. Johns to Lowell, Michigan viii 230 237 243 245 251 253 CHAPTER I SUBSIDIZING RAILROAD LINES: AN ANALYTICAL GAP Collapse of the Penn Central TranSportation Company and subsequent massive railroad line abandonment prOposals triggered unprecedented attention to problems developing for more than half a century. Capital shortage has plagued the railroad industry since the Great Depression. Recent federal policy actions have shifted a.portion of the capital bur- den on lines with light traffic density to users of services or collec- tives Of users. Railroad companies have new opportunities to evaluate lines on the basis Of market criteria. States and communities have new Opportunities for public investment to provide services with related nonmarket attributes. The research reported here has been.approa¢hed to compromise two Opposing missions. One mission has been to develop a framework for extended research on the role of various economic participants in structuring an active transportation policy for lightly traveled rail- road lines. The second mission.has been to contribute to solution of the immediate problem of state governments, that of determining which lines to subsidize under provisions of the Regional Rail Reorganization Act. The two missions have revealed themselves to be much.more comple- mentary than at first thought. Sketches of the economic and institu- tional environments of railroading and major emphasis upon economic theory as a deductive guide dominate this initial research. Empirical applications are rudimentary and each individual tOpic is rich with opportunity fOr methodological refinement. Empirical work has been approached with extreme care to create realistic impressions for those who may use these results. The particular purposes of this research are to determine railroad freight transportation.market characteristics and to develop market and social investment and disinvestment criteria for railroad.branch lines. Markets are typically characterized.by technical and behavioral boundary functions separating feasible and infeasible or rational and irrational actions. Economic criteria are described by particular points on these boundary functions.‘ Long run demand and.production- investment considerations are used to establish the market bound to provision Of railroad service. A long run excess cost relationship provides a means to measure magnitudes of subsidy necessary to encour- age retention Of service levels deviating from partial market equilib- ria. Social demand and cost functions establish the social bound to provision Of railroad service. The bankruptcy and abandonment.plans of the Penn Central Railroad shocked Michigan. Nearly a third Of Michigan's lines are owned and operated.by the Penn Central. .An active abandonment program by the Chesapeake and Ohio Railroad, bankruptcy Of the Ann Arbor Railroad and failures of Lake Mfichigan ferry services added to state concerns. In.view Of these concerns, the Michigan.Pub1ic Service Commission, in their session of December 22, 1972, ordered each railroad company own- ing or Operating lines in.the state of Midhigan.to appear for a.hearing. The order included a written reSponse to a questionnaire and appearance before a hearing examiner for a nonadversary examination. The Commis~ sion's purpose was "to apprise itself Of the presentsituation and pro- blems in and about the state of railroads and railroading in the State Of Michigan, and to become more informed as to the future of railroads and railroading in the State."1 During the hearings, conducted during February and March, 1973, the major railroads Operating in the state rebuked abandonment review procedures practiced by the Commission. The railroads interpreted existing state policy as Opposition to all abandonment activity except for infrequent nonintervention in the clearest cases Of line failure. TO the railroads, abandonment review procedures of the state appeared inconsistent and lacking in basic guidelines. By June, 1973, the complexion of the Regional Rail Reorganization Act was unfolding. Basic in several proposals was facilitated ration- alization Of railroad properties with options for states, conmnmities and shipper groups to salvage unprofitable lines by subsidy or purchase. The Governor of Michigan established an Interagency Task Force on Rail- road Needs , in June. The Task Force was to determine which railroad lines were essential for Michigan commerce and future development. An investigatory branch of the Task Force was established in the Michi- gan Department of State Highways and Transportation. An atmosphere of uncertainty dominated the autumn of 1973 while Congress composed the final form of the Regional Rail Reorganization Act. The bill was signed into law January 2, 1974. The Secretary 1Michigan Public Service Commission, Order and Notice Of Hearing, File No. RR—699Z, issued December 22, 1972 and amended January 29, 1973, Lansing, Michigan. of Transportation was given thirty days to develop a report on the rail- road system Of states in the Northeast and Midwest. The report, reveal- ed on the first day of February, suggested that nearly half of the rail- road route mileage Of lower peninsula Michigan was "potentially excess." Comrmmities, railroad users and state agencies with concerned clientele reacted immediately and emotionally to the thought of losing railroad service. ‘ Interaction with state Officials, railroad users and comnnmity leaders revealed a common insecurity in the lack of analytical tools with which to judge the convenience and necessity Of retaining railroad service. Sound policy requires systematic treatment of facts involved in an issue. The issue confronted by comrmmities, railroad users and state agencies presents itself in two time frames. How is each group to respond to forthcoming federal proposals for railroad line removal? In the longer run, how is each group to respond to subsequent, individu- al line abandonment cases? The problem in both periods can be treated similarly. The new railroad law provides jurisdiction and partial fund- ing to subsidize continued operation of unprofitable lines or loans to purchase lines considered to be excess. Each group must develop an approach to determine whether or not to subsidize or purchase a line. The public need for basic information and criteria with which to make“ these judgments provides the motive for this research. Historical perspectives of the railroad capital shortage problem and Of legal precedents establishing rules for distribution Of property rights associated with railroad assets are reported in Chapter II. Chapter III is devoted to analyzing the supply side of market provision of railroad service. From criteria established with a long run.produc- tion-investment model, a.measure of subsidy necessary to encourage Operating companies to retain currently unprofitable lines is determined. The limits of alternative railroad.pricing policies and of private col- lective action are also considered. Elements of market demand are dis- cussed in Chapter IV. Demand functions, including service quality in- fluences, and.moda1 split relationships are measured for various com- modity groups. Chapter V is devoted to considerations of demand for railroad service which are not communicated through the market price mechanism. Concepts developed in Chapters III-V'are applied to a two county region Of Michigan, in Chapter VI, with.the purpose of exempli- fying evaluative procedures. The breadth of this undertaking has fOrced the author to set aside numerous topics for research which exposed themselves during the course of this endeavor. Some of these research- able questions are summarized together with conclusions and.policy hm- plications of this work, in the final chapter. CHAPTER II THE EVOLVING ECONOMIC AND INSTITUTHNWU;IENHJKDOEDH'OF RAILROADING Railroading has had a colorful history of high finance and tough legal battles. Over the near century and a half Of American railroad- ing, the life cycle of an industry has been displayed. From the early days Of excited youth, through the growing pains of adolescence , to maturity, and now to a degree of senescence, the economic and institu— tional environments surrounding the railroad industry have evolved along the way. Put in perspective with earlier times, contemporary railroad problems appear to be the same as they have been for years, except in degree. This chapter is included to develop this perspective by Ob- serving the recent past. Special attention is given to the perennial railroad capital shortage problem and the set of property rights which have been developed to distribute control over railroad resources and the implications Of use. The Regional Rail Reorganization Act Of 1973 will be reviewed briefly to note implied changes in prOperty rights and means to finance lightly traveled rail lines. The Railroad Capital Shortage Problem The capital shortage problem is not new to the railroad industry. As a maturing, capital intensive industry strictly constrained by market competition and regulatory policy, railroads have found increasing dif- ficulty obtaining attention Of the capital market. A short history of railroad capital problems adds perspective to current shortages. Net real capital formation reached its peak in 1911 while the real value of road and equipment grew at a decreasing rate until the Great Depression. Ulmer demonstrated that net capital formation in railroading has occur-- red in long cycles which reflect, but are not overshadowed by, general business cycles.1 From the all-time peak of 1911 until 1950, these long cycles grew in length, up to twenty years by the end of his study, and amplitudes reflected a tendency toward increasing contractions and de- creasing emansions. Thus, a secular decline in net railroad capital formation has occurred since before World War I . A sharp decline in capital formation reached a trough during World War I with rapid recovery after passage Of the Transportation Act Of 1920, encouraging development of a peacetime railway system. The years of depression devastated the capital positions of *the entire industry. "During the depression of the 1930's aboutone-third of all railroad mileage was in the control of receivers or trustees."2 Potential in- vestment from greatly expanded traffic during the second World War was stymied by material shortages. The end of depression and inflated wartime traffic volunes trigger- ed a false sense of optimism for the decade of the fifties. Forecasts of continued high revenues brought recommendations for major investment programs in railroad fixed plant. Emory Johnson estimated that though 1Melville J. Ulmer, Trends and les in ital Formation b United States Railroads 1870-1950,%casiona1 Eaper 43 (New YorE: Na- tional Bureau Of Economic Research, Inc. , 1954), pp. 25- 36. 2John L. Weller, "Access to Capital Markets," in The Future Of American Transportation, ed. by The American Assembly (Eh—fie wood CIiffs , N..:J Pfentice-Hall, Inc., 1971), p. 85. motor carriers had caused railway travel to shrink to one-third Of its one-time volune, "the tide has turned and the trend of travel by rail is again upon an upward curve."3 With more guard James Lyne foresaw that "the nation's reliance on railway transportation is considerably less percentagewise in peacetime than in war, but is still large, with indi- cations that its decline may have been arrested.” Post-war optimism was shared neither by railroad management nor by investors. , With the experience of the thirties clearly in mind and great uncertainty clouding the future, railroad management used wartime caches to pay off debts rather than invest in capital improvements. Simultaneously prices of railroad securities were extremely low reflect- ing the reluctance Of investors to supply capital to the industry. View- ing the fifties in hindsight, Nelson describes the unfulfilled Optimism for the decade. The economic position Of the railroads has deteriorated seriously since the end of World War II. In 1945 the roads ap- peared to have excellent prospects. . _. . But notwithstanding the factors favorable to railway progress, the past decade has been a period of stagnation rather than growth. Once again, the railroads have the symptoms Of a "sick" industry, and, with few exceptions, there is no assurance that their health will improve substantially in the near future.5 The troubling feature Of the stagnation of the fifties was the , 3Emory R. Johnson, The Railroads and Public Welfare: Their Pro- blems and Policies (New York: Shamans —Boardman Publishing Corporation, 1944), p. 1. l“James. Garnett Lyne, The Need of the Railways for Additional Fixed- Plant Capital and Possible Means OF its Attainment (New York: Simmons- Boardman Publishing Corporation, 1948), p. 3. 5James C. Nelson, Railroad Transportation and Public Policy (Wash- ington, D.C.: The Brookings Institution, 1959), p.7. accompanying general state of economic prosperity, unlike the conditions surrounding railroad stagnation of the thirties. Low rates Of capital investment continued through the anti-merger years of the early sixties. In the latter half of the decade capital expenditures by railroads rose considerably, 60.5 percent above the 1960-1964 level.6 HOwever, nearly three-quarters of all railroad capi- tal expenditures in this period were allocated to equipment with the remainder applied to roadway and structures. Equipment purchases have continued strongly into the 1970's with massive but less than conmen- surate retirements. Table 1 shows the pattern of growth in standing freight car capacity resulting from emphasis on equipment purchases. Short experience of the 1970's reveals a greater proportion of capital expenditures going to roadway and structures but no more in absolute dollar terms than in the latter half Of the 1960's, as seen in.Table 2. The year 1966 may represent the peak ending the long period investment cycle beginning with.Ulmer's last reported peak of 1946. Ulmer's study of capital sources for railroad investments reveals the market in which railroading must appear attractive.7 Prior to 1907 internal corporate financing of investments was negligible. Sales of stocks and bonds composed 90 percent Of all capital acquisitions. Adop- tion Of depreciation accounting and finance with retained earnings led railroads to finance about 40 percent Of capital requirements with in- ternal resources, during the long cycle of 1907-1916. The trend toward internal financing intensified. During the thirties much of internal 6Weller, "Access to Capital Markets," p. 86. 7Ulmer, Capital Formation, pp. 46-49. 10 Table 1. Standing Freight Car Capacity* for the united States: 1960-1973 Average Standing Year Cars Capacity Capacity (Number) (tons/car) (thousand.tons) 1960 1,965,486 '55.4 108,888 1961 1,905,268 55.7 106,123 1962 1,850,688 56.3 104,194 1963 1,814,193 56.8 103,046 1964 1,796,264 58.3 104,722 1965 1,800,662 59.7 107,500 1966 1,826,499 61.4 112,147 1967 1,822,381 63.4 115,539 1968 1,800,375 64.3 115,764 1969 1,791,736 _ 65.8 117,896 1970 1,784,181 67.1 119,719 1971 1,762,135 68.4 120,530 1972 1,716,937 69.6 119,499 1973 (est.) 1,710,659 70.5 120,601 Source: Yearbook Of Railroad Facts, 1974, Association of American Railroads, pp. 51, 53. *Standing freight car capacity is the product Of average car capacity and number of cars. True capacity is de- pendent upon the rate of turnover in use. 11 Table 2. Expenditures for Capital Improvements by U.S. Railroads: 1960-1973 Roadway 8 Roadway 6 Year TOtal Equipment Structures Structures (thousands of dollars) (Percent) 1960 919,154 633,490 285,664 31.08 1961 646,425 427,130 219,295 33.92 1962 832,938 593,369 239,569 28.76 1963 1,043,788 784,874 258,914 24.81 1964 1,417,263 1,139,683 277,580 19.59 1965 1,630,687 1,303,602 327,084 20.06 1966 1,952,805 1,554,223 398,581 20.41 1967 1,522,478 1,148,381 374,097 24.57 1968 1,186,979 818,720 368,259 31.02 1969 1,509,394 1,088,712 420,681 27.87 1970 1,351,439 993,095 358,344 26.52 1971 1,177,627 863,517 314,110 26.67 1972 1,215,581 847,623 367,958 30.27 1973 (est.) 1,342,138 892,690 449,448 33.49 Source: Yearbook of Railroad Facts, 1974, American.Association of Railroads , p. 57. 12 financing occurred with defaults on bonds and interest on debt. Inter- nal financing reached a peak during the forties when nearly all capital requirements were serviced internally; As noted earlier, wartime earn- ings were even used to retrieve stocks and bonds outstanding. Since WOrld war II total internal financing has not been.possible due to high operating ratios.8 Table 3 shows recent Operating ratios for Mfichigan and system Operations for railroads found in.the state of Michigan. Though NOrtheastern railroads have been forced to incur external debt, a recent Department of Transportation reply to a questionnaire from Congress revealed that recent railroad bankruptcies have not been caused so much by unmanageable debt structure as by insufficient earnings from operations. Revenues have simply been so small relative to Operating expenses as to leave insufficient cash to cover fixed charges. various reasons have been developed to explain the railroads' inability to attract capital and generate revenues. .Attraction Of capi- tal is inhibited by the uncertain financial outlook for railroads as a result of a mixture of several conditions. Revenues sufficient to cover fixed charges tend to be consumed in noncapital expenditures or inhibited by inability to compete under current economic and policy con- ditions.\,Causes of railroad decline include inflexible rate regulation,_ inefficient labor work rules, risinngaterial and fuel costs, differenr tial property taxation, public subsidization of competing modes, compar- atively disadvantageous economic structural shifts, and unresponsive abandonment procedures. 5 8Operating ratio denotes railroad Operating expenses as a propor- tion of Operating revenues. Smaller ratios imply more fUnds left to cover capital charges after variable expenses. 13 TABLE 3. System and State Operating Ratios* for Michigan Line—Haul Railroads: 1968-1972 (hes ake Chicago 8 Ann Arbor Boyne City“ 8 '0 Northwestern System State System State Systan State System State 1968 85.46 94.35 48.23 48.23 79.4 76.5 85.43 86.03 1969 92.68 101.96 55.99 55.99 80.9 78.2 87.97 98.65 1970 85.05 93. 52 151. 29 151. 29 78 . 8 76 .1 81. 29 101 . 17 1971 91.98 93.64 188.68 188.68 80.7 78.5 80.50 104.06 1972 93.07 --- 105.79 105.79 70.2 74.2 79.47 --- Milwaukee Detroit 8 Detroit 8 Detroit, Toledo Road Mackinac“ Toledo S.L. 8 Ironton 1968 81.71 66.97 82.85 82.85 70.45 70.45 71.69 50.58 1969 85 . 70 61 .61 88. 89 88. 89 73 . 26 73. 26 73.09 55 .61 1970 85.84 111.00 87.67 87.67 73.28 73.28 77.44 62.84 1971 82.20 81.99 86.03 86.03 70.42 70.42 74.35 60.19 1972 84.84 --- 82.79 82.79 69.88 69.88 73.94 --- Escanaba 8 Grand Trunk Lake Stperior Norfolk 8 Lake Superior“ Western 8 Ishpaning“ Western 1968 77.02 77.02 82.5 82.2 78.98 78.98 69.74 106.17 1969 93.98 93.98 89.6 87.7 72.31 72.31 69.88 104.68 1970 106.56 106.56 105.1 105.0 80.68 80.68 72.02 106.30 1971 110.82 110.82 90.3 90.2 91.85 91.85 72.51 90.46 1972 113.44 113.44 89.2 88.1 99.45 99.45 71.17 87.45 Port Huron Penn Central 8 Detroit“ 500 Line 1968 83.62 --- 62.45 62.45 75.38 63.35 1969 85.60 --- 57.58 57.58 75.57 63.74 1970 92.08 --- 73.02 73.02 73.76 70.56 1971 88.01 --- 69.97 69.97 74.11 70.11 1972 84.09 --- --- --- 72.81 67.54 Source: Marc A. Johnson, Surinam: Midngg Public Service Coumission Railroad Hearigg, “ The ratio of Operating cost to operating revenue is shown in percentage terms. July, 1973. ** Railroads wholly contained within the state. F'. _(.) 14 Rate regulation is criticized by railroads and many economists as responding to market changes too conservatively and too late. Inability of rates to move quickly with market conditions tends to discourage traffic in overpriced markets and stifle revenue generation in under- priced markets. Too, accounting schemes for allocation of joint and conmon costs often distort railroad service prices from those which would give either the railroads a higher revenue or the public a level of service for which they are willing and able to pay. Rates tend to be raised in an "across the board" fashion which does not necessarily reflect market conditions . Labor work rules established by labor-management negotiation are said to require inefficient overuse of railroad employees in individual Operating tasks. Most notable has been the featherbedding dispute over whether train firemen are to be retained. Unnecessary workers, manage- ment maintains, is a major cost item at rapidly rising wages. These payments in wages reduce revenues applicable to fixed charges . Another drain on revenues is rapidly rising prices Of fuel and othermaterials required in operating a railroad. When material and fuel prices rise relative to freight rates, net revenues are pinched, reducing earnings which may be applied to capital formation. Methods of state fl valorem taxation have been criticized for more than a decade for unfairly valuing railroad properties above the values Of adjacent lands or assessing higher rates than those charged to local property. The debate grew hot between railroads and local governments during the 1960's and many state govermnents moved to equalize tax treatment. Michigan has been above the dispute since collection of raierad a_c_1 valorem taxes is a state function. 15 1By a process Of elimination, Lyne concluded that the single most important cause of the railroads' poor postewar capital position was the implicit public differential subsidization bf competing transport.modes:Ej Public investments in highways, waterways and airways and airports with- out charges on traffic proportional to cost tend to allow pricing of users' services below cost, giving user modes an advantage in transport markets, leading to overinvestment in competing modes and underinvest- ment in railroads. uncertainty associated with.public investment poli- cies tends to dampen the railroad outlook. There is hardly a major railroad in the country which does not face the probability of being paralleled by a toll-free highway Of the "super" category, which should greatly decrease costs Of truck operation and increase speed, without any commensurate addition to the charges on the specific traffic which.immedi- ately benefits from the facility.1‘° Similar conclusions are reported for waterway, airway and airport de- velopments. Emory Johnson also views implicit public differential sub- sidization of modes as the chief problem behind the railroads' loss of traffic.11 His argument is based not on "fair treatment" Of modes but upon the pricing distortion whidh affects "the development and.mainte- nance of a well-balanced, efficient and economical national transporta- tion system." I Major structural shifts in the economy have also been used to ex- plain sluggish growth Of railroad demand. Emory Johnson was early in explaining that economic structural shifts may create a shift in 9Lyne, Fixed-Plant Capital, p. 149. 10Ibid., p. 153. 11Emory Johnson, Railroads and Public Welfare, pp. 14-15. 16 comparative advantage of transportation away from railroads.12 Economic moves Johnson cited are shifts of energy production to raw material sites with.more extensive transmission line webs for power distribution and shift to electric and fuel Oil power sources allowing wide-scale decentralization of industry with emphasis on.marketing and distribution functions which favor motor carriage. The Task Force on Railroad Productivity Of the National COmmission on Productivity attributes the railroad problem to several characteris- tics of the dynamic transport market: 1) general slow growth Of inter- city freight traffic, 2) altered composition of freight traffic, 3) changing spatial pattern Of commodity flows, 4) development Of new modes strengthening intermodal competition, and 5) lagging management and regulatory progress falling behind the pace of a changing market envir- onment.13 As economies mature freight volumes in general and freight suited for railroads tends to grow less rapidly than the output of the general economy. This is demonstrated.by comparing post-war rates of growth in intercity traffic and gross national product. In the period 1947-1972 total intercity freight tonemiles, excluding oil pipelines, grew 2.2 percent annually compared with annual gross national product growth of 3.8 percent.1“v Evolution of the economic structure has also brought changes in the patterns of composition and distribution of traffic. Bulk commodities, 12Ibid., p. 33. 13Task Force on Railroad Productivity, Improvi Railroad Produc- tivigy, Report to the National Commission onIProduct1vity and the Coun- c1 0 Economic.Advisors, NOvember, 1973 (washington, D.C.: National Commission on Productivity, 1973), pp. 1-50. ll*Ibid., p. 3. 17 for which railroads hold an advantage, tend to be highly income inelas- tic. Increased consumer-incomes tend to create demands for labor and capital intense products and services rather than products of high raw material requirements. Technological developments Of raw material sub-1 stitutes and material economy~have tended to replace lowvvalue, bulk material movements suCh as coal and glass with.higher valued petroleum and plastic which favor motor carriage. A higher proportion of traffic is generated in.manufactured products which require higher service standards than bulk materials. Bulk commodity hauls are increasing in length and density whiCh favor railroad traffic retention, but replacements Of raw building materials with synthetics and.petroleum for coal tends to favor other modes. The trend toward decentralization Of manufacturing industries toward market oriented.operations slows growth.in traffic in manufac- tures and deconcentrates deliveries, making trucking more competitive both.in.volume and cost. While product differentiation.has dampened decentralization Of'production, again size of shipments are reduced detracting from railroad advantage. The long~term.evolution to subur- banized residential patterns and subsequent dispersion of wholesale and retail sales has made the flexibility of motor carriage very attractive for movements of final manufactured goods. The consequence of changing composition and distribution patterns has been a declining share of railroad participation in total intercity freight movements. The railroad share of total intercity freight ton- miles has steadily declined from 65.3 percent in 1947 to 38.7 per cent in 1971. The share for motor carriage has remained stable near 21.5 percent since 1958, but has been increasing relative to the share of 18 freight movement by railroads . Total tons originated by railroads dur- ing the 1970's have not changed appreciably since 1966 nor do tonnages differ greatly from traffic originated during the post-war forties.15 Modes growing fastest are air, pipeline, and river carriage. Air trans- port remains relatively insignificant carrying less than one-fourth of one percent of total intercity freight ton-miles during 1970 and 1971, though receiving a much higher relative share of total traffic revenues . Pipelines and inland water carriage compete with railroads for bulk conmodities while trucks cornpete most strongly for manufactured goods. The railroads are caught in the middle of major new developments in other modes of transport. Finally, policy toward rail line abandonments has been cited as a major cause Of railroad capital problems. The argunent is that slow, expensive abandonment procedures inhibit adjustment by railroads to changing economic and social circumstances. This argunent was one of the most strongly and consistently expressed by line haul railroad carriers in 1973 hearings before the Michigan Public Service Commis- sion.16 Weller suggests that the problem of overcapacity in fixed rail plant is one root cause of railroad inability to adjust to a changing environment . . . . the breakdown of the railroads leading to their take- over by the federal government in World War I seems to have resulted from overbuilding Of the system and from refusal Of 15Association of American Railroads, Yearbook of Railroad Facts: 1974 Edition (Washington, D.C.: Association of Merican Railroads, , p. 0 16Marc A. Johnson, Sunmag: Michigg Public Service Commission Heari s, Reporttto the Michigan Public ervice Commission, Lansing, mafiigan, July, 1973 (East Lansing: Department of Agricultural Econo- mics, 1973), pp. 52-53. 19 the Interstate Commerce Comission to permit rate increases be— tween 1910 and 1915, a period when railroad wages and other costs were rising rapidly. The problen of rail capital inflow began at that time, before the roads had been eXposed to significant competition from other modes.” An early study of railroad abandonments by Cherington provides sup- port for this view. In the first attempt by any railroad to reorganize with a massive abandonment plan, the ICC initially refused more than half of the Boston and Maine's applications.. The commission said The evidence seems to be conclusive that not a few of the lines which it is now proposed to abandon should never have been built. At the time Of their projection as independent enterprises it seems to have been understood that some Of them were built for purely competitive or strategic reasons. . . But irrespective of the origin of an existing line, people gather about it and create for themselves an interest in and a dependence upon it.18 Meyer terms these effects of reduced property values "transition capi- tal cost problems"-which he dirninishes in cases where substitute modes or modified transport technology can handle abandoned railroad traffic, even at some higher cost.1‘3 The Boston and Maine applications, refused in 1925, were granted expeditiously with the advent Of the Great De- pression. The actual cause or mix Of causes of railroad capital problems ap- pears in a state of uncertainty. Conclusions on the cause Of the rail~ road capital problem have been drawn from educated conjecture. The battle of quotations from prominent and experienced professionals does 17Weller, "Access to Capital Markets ," p. 92. 18Charles Cherington, "11. Railroad Abandorment in New England, 1921~37," Journal of Land and Public Utility Economics, 14 (May, 1938), 191-200. 19John R. Meyer, et a1. , The Economies of Competition in the Transportation Industriés'TCambridge: Harvard University Press , 1960) , pp. 256-257. 20 not suffice. While identification of the actual cause of railroad capi- tal problems is not the subject of this research, theoretical and empi- rical developments are designed which will describe the implications of both railroad abandonment policy and traffic shifts on railroad capital requirements . - A Half Century of Line Abandonments Shifting markets and financial woes have encouraged railroad firms to seek removal of lightly traveled roadway. ~ Programmed abandonment policy for major firm readjustments has been thwarted by the regulatory process. The result has been resignation to the piecemeal approach Of numerous applications tO abandon small segments of trackage. Table 4 reveals the magnitude and disposition of abandonment behavior since the Interstate Commerce Commission was charged with responsibility to over- see line extensions and contractions . Table 5 is included to demonstrate the downward trend in new line extensions, reinforcing the total decline in national roadway mileage. Throughout the decade of the twenties , new roadway extensions more than Offset line closures. This condition was reversed during the De— pression of the thirties and the absolute decline in rail lineage has continued since. In the fifty-three year period of ICC roadway super- vision, permission has been granted to abandon five times as many miles Of roadway as has been granted to new extensions . An average Of eighty-eight applications to abandon roadway have been granted each year of the period 1921-1973, affecting an average of 1,294 miles annually. Number of applications approved and mileage affected move together. During the decade of the twenties, the last 21 TABLE 4. Applications for Certificates of Public Convenience and Necessity to Abandon Railroad Lines in the united States, 1921-1973.* Applications Granted Denied Cumulative Granted Year Number Miles Number Miles Number Miles Number Miles 1921 49 910.00 40 701.94 28.00 40 701.94 1922 47 808.46 30 526.53 78.82 70 1,228.47 1923 36 964.94 19 523.41 1.5 89 1,751.88 1924 52 949.82 30 453.84 69.13 119 2,205.72 1925 57 883.21 46 651.98 14.66 123 2,857.70 1926 46 937.19 49 592.56 73.30 172 3,450.26 1927 56 792.26 52 830.61 106.92 224 4,280.87 1928 53 752.21 61 587.05 59.72 285 4,867.92 1929 69 834.92 48 539.54 16.72 333 5,407.46 1930 75 980.83 72 1,807.46 226.24 405 7,214.92 1931 88 1,075.53 89 1,019.31 42.07 494 8,234.23 1932 114 2,281.43 90 1,418.27 40.60 584 9,652.50 1933 153 3,263.22 129 2,404.26 33.97 713 12,056.76 1934 125 2,013.49 154 2,514.22 161.55 867 14,570.98 1935 122 2,537.17 100 1,691.82 310.43 967 16,262.80 1936 125 1,896.89 116 1,903.00 1937 134 2,179.28 116 1,547.37 1938 127 2,470.62 123 2,014.06 1939 121 2,561.78 106 2,137.80 1940 115 1,781.44 124 1,919.40 1941 139 2,317.58 111 1,938.24 1942 227 3,534.93 184 2,407.14 1943 116 1,508.72 146 1,782.77 111.86 1,083 18,165.80 93.80 1.199 19,713.17 63.03 1,322 21,727.23 60.51 1,428 23,865.03 84.27 1,552 25,784.43 109.35 1,663 27,722.67 308.46 1,847 30,129.81 349.14 1.993 31,912.58 r-u-u—I mwwmszmwzwmmmzmmHowHzmmwmwmzwmmmmmmmmmmmwwmwwmmeHmH 1944 72 1,173.18 61 801.33 343.76 2,054 32,713.91 1945 45 674.40 55 801.98 123.61 2,109 33,515.89 1946 60 1,747.24 37 669.79 273.09 2,146 34,185.68 1947 85 1,073.50 63 1,241.11 2.00 2,209 35,426.79 1948 65 781.31 57 907.36 49.30 2,266 36,334.15 1949 80 1,177.80 51 873.31 28.72 2,317 37,207.46 1950 71 886.29 80 954.62 109.50 2,397 38,162.08 1951 69 815.12 58 566.44 181.09 2,455 38,728.52 1952 91 1,294.13 84 1,305.75 98.59 2.539 40,034.27 1953 72 976.01 77 1,101.68 6.22 2,616 41,135.95 1954 61 497.63 69 999.74 14.42 2,685 42,135.69 1955 80 975.82 62 428.73 — 2,747 42,564.42 1956 58 731.35 69 822.71 44.82 2,816 43,387.13 1957 74 1,190.45 65 588.51 88.82 2,881 43,975.64 1958 96 2,061.84 85 1,825.36 50.50 2,966 45,801.00 1959 86 1,203.20 94 1,179.73 136.72 3,060 46,980.73 1960 100 1,681.56 69 771.82 120.20 3,129 47,752.55 1961 98 1,140.54 101 1,167.16 376.32 3,230 48,919.71 1962 122 1,869.13 95 1,582.28 53.15 3,325 50,501.99 1963 127 1,937.40 110 1,688.40 72.65 3.435 52,190.39 1964 109 1,528.18 83 811.32 74.12 3,518 53,001.71 1965 107 2,224.0 117 1,538.5 121.3 3,635 54,540.21 1966 106 1,920.1 92 1,054.4 334.0 3,727 55,594.61 1967 72 860.0 85 817.3 95.5 3,812 56,411.91 1968 76 2,036.3 74 1,890.4 76.1 3,886 58,302.31 1969 136 2,286.6 89 1.319.8 12.2 3.975 59,622.11 1970 104 1,762.0 82 1,782.0 64.9 4,057 61,404.11 1971 241 3,142.3 129 1,286.6 39.5 4,186 62,690.71 1972 273 3,978.4 268 3,457.7 47.9 4,454 66,148.41 1973 266 4,436.3 198 2,428.3 153.5 4,652 68,576.71 *Emdiammmlcnnryums(finahmo:fimm'flweanrenmmdhg.~uwmllkpmfl:ofthe Interstate Cannerce Coumission. ‘ 'IABLE 5. 22 Applications for Certificates of Public Convenience and Necessity fOr New Line Extensions in the United States, 1921-1973.* Applications Granted Denied Cumulative Granted Year Number Miles Number Miles Number Miles Number Miles 1921 67 39 404.70 , 39 404.70 1922 53 2,941.28 27 446.33 6 259.35 66 851.03 1923 50 2,914.51 28 881.59 2 15.75 94 1,732.62 1924 42 2,564.66 26 1,318.35 7 2,298.60 120 3,050.97 1925 73 3.512.50 46 908.84 3 234.03 166 3,959.81 1926 51 1,280.52 52 1,573.70 10 503.12 218 5,533.51 1927 41 1,257.73 39 1,027.27 10 593.86 257 6,560.78 1928 46 1,380.79 33 717.19 5 222.19 290 7,277.97 1929 79 3,307.26 45 618.20 8 464.48 335 7,896.17 1930 37 737.83 54 1,596.01 5 247.50 389 9,492.18 1931 21 319.40 29 244.05 6 106.73 418 9,736.23 1932 9 850.86 11 38.03 10 952.87 429 9,774.26 1933 12 491.29 8 32.30 5 23.77 437 9,806.56 1934 8 174.453 19 70.54 4 881.73 456 9,877.10 1935 11 196.91 13 88.67 2 128.00 469 9,965.77 1936 7 106.96 6 105.08 1 236.20 475 10,070.85 1937 17 97.28 8 38.20 0 - 483 10,109.05 1938 5 237.23 11 36.659 1 210.00 494 10,145.71 1939 8 45.54 4 29.77 2 10.08 498 10,175.48 1940 13 37.31 9 27.41 0 - 507 10,202.89 1941 14 50.34 17 44.84 1 9.51 524 10,247.73 1942 6 24.86 6 37.61 1 1.95 530 10,285.34 1943 8 43.98 6 39.17 1 .08 536 10,324.51 1944 25 152.78 16 73.26 2 4.40 552 10,397.77 1945 16 101.22 14 138.04 2 12.90 566 10,535.81 1946 20 159.45 10 47.36 2 3.25 576 10,583.17 1947 20 335.35 16 133.37 2 14.00 592 10,716.54 1948 22 126.39 18 116.78 1 229.00 610 10,833.32 1949 12 104.57 9 80.95 1 4.00 619 10,914.27 1950 12 83.50 13 43.04 1 4.50 632 10,957.31 1951 21 154.18 15 92.26 1 7.00 647 11,049.57 1952 13 72.58 8 32.55 2 17.40 655 11,082.12 1953 22 161.04 13 64.52 3 10.49 668 11,146.64 1954 11 49.56 9 86.88 1 1.51 677 11,233.52 1955 17 95.98 10 48.27 1 5.50 687 11,281.79 1956 14 75.69 14 89.30 4 13.04 701 11,371.09 1957 8 42.52 10 54.44 3 13.54 711 11,425.53 1958 10 88.44 10 77.92 1 .79 721 11,503.45 1959 13 135.90 9 62.31 1 9.07 730 11,565.76 1960 14 44.11 10 68.06 1 .90 740 11,633.82 1961 22 99.18 20 60.29 3 18.67 760 11,694.11 1962 9 14.09 12 26.34 2 36.03 772 11,720.45 1923 20 164.13 10 15.49 1 .95 782 11,735.94 19 1965 20 202.6 18 275.8 5 56.5 800 12,011.74 1966 20 166.0 15 127.4 1 14.8 815 12,139.14 1967 15 142.1 20 201.6 0 - 835 12,340.74 1968 12 142.1 9 121.3 2 51.4 844 12,462.04 1969 13 79.4 17 98.7 1 26.7 861 12,560.74 1970 11 70.2 5 37.0 0 - 866 12,597.74 1971 13 669.5 12 616.9 0 - 878 13,214.64 1972 10 41.9 10 22.7 0 - 888 13,237.34 1973 11 261.6 5 84.7 2 5.1 893 13,322.04 'Ehdhaummalemnryiuu;obtahmo.fnm1thecannespmmfinglhmmal[Eportcn3the Interstate Canerce Ooumiss ion. 23 period Of significant roadway~building, number Of abandonment applica- tions granted oscillated near half the fifty-three year average. The Depression brought a sharp rise in requests and approval Of abandonments as one means to save a beleaguered industry; Interest remained high until the united States became involved in the second WOrld war. Through- out the war period and the postewar forties and fifties, number of aban- donment applications granted.remained below the fiftyethree year average. During the merger movement Of the sixties, the annual number Of abandon- ment certificates granted rose to the average level for the entire period. The late sixties brought the culmination of several large mer— gers and a succession Of railroad bankruptcies ensued. These forces have led to the highest level of abandonment activity in the nation's history. New line extensions have taken the opposite pattern. During the period 1921-1973, an average of seventeen cases were approved annually for an average of 256 miles per year. During the decade Of the 1920's, yearly number of certificates granted was far above the fifty-three year average; extensions exceeded abandonments. Since the beginning of the Depression, interest in extending rOadway plants has remained below the fifty-three year average, with few exceptions.- The State of Michigan has experienced some Of the most intense abandonment activity in the nation. Of the forty-eight contiguous states, Nfichigan.ranked second in.number of roadway~miles affected.by certifi- cates to abandon, between 1921 and 1945; only Texas had.more mileage affected.20 During the same period, the state ranked'fourth in.percent , 20Charles R. Cherington, The Re ‘1ation of Railroad.Abandonments (Cambridge: Harvard University Press, 1948), pp. 1054106. 24 of total state mileage with certificates to abandon roadway, following New Hampshire, Nevada and New Mexico.21 The recent national trend of accelerated abandonment action.has also affected.the state with.strong intensity. Of the 6,614 mile rail- road plant present in Michigan in 1965, abandonments and lack Of exten- sions reduced roadway by six percent by the beginning of 1973.22 Another nine percent of the state's current 6,223 miles of roadway was under formal application for abandonment when a District Court Of Penn- sylvania ordered applications held in.abeyance, pending report of a re- lated environmental impact study; More than half of these lines involve the package of Penn Central proposals to abandon large sections of road- way. Property Rights and.RailroadingResources iRailroad abandonment is not a new phenomenon, but the signifi— cance of railroad line closures to the economy and the public interest has changed continually for more than.a century. Railroad regulation has defined two concepts of the "public interest." The national public interest has been interpreted as preservation of a complete and effici- ent national transportation system. The local public interest has been identified as protection of individual and community prOperties and opportunities. Legal protection of these public interests has evolved as local, state and federal agencies have considered effects associated with abandonment actions. The product of this evolution is a set Of 21Percentages are based in.year 1943 to take account Of new line extensions. 22This calculation was derived from.infbrmation in the files of the Michigan Public Service Commission. 25 basic legal principles and practices governing public control of rail- road 1ine closures. A.brief historical sketch of regulatory princhples and.practices will reveal the institutional environment shaping actions. This review, drawing completely upon the work of others, focuses upon the few basic principles which have governed the distribution Of rights associated with railroading resources. Public influence over line closures was evidenced as early as the 1860's. Though federal jurisdiction was not established until passage of the Transportation.Act of 1920, states acted early to influence rail roadway dispositions.23' Earliest public control operated through state courts in response to individual plaintiff protests. State courts de- veloped the principle that companies established to serve the public interest held no obligation to continue this service unless such com- panies were granted Special rights and privileges by the peOple. Since railroads received special privileges in terms of powers of eminent domain, land grants and local financial assistance, state courts found railroad companies obliged to the people of respective states to centinue services initiated under privilege. Locklin provides one example in the spirit of the following quotation from a Kansas Supreme Court ruling of 1894. The railway corporation takes its franchises subject to the burden of a duty to the public to carry out the purposes Of the charter. The road, when constructed, becomes a public instrumentality, and the roadbed, superstructure, and other 23Charles R. Cherington, Railroad.Abandonments, pp. 17-25. 26 permanent property of the corporation are devoted to the public use. From this use neither the corporation itself, nor any person, company, or corporation deriving its title by purchase . . . can divert it without the assent of the state.”+ .A single exception to this principle applied to Operating compan- ies faced with incipient financial failure. The state was prohibited from forcing maintenance Of service on lines when such continuance threatened financial solvency of an entire system. Enforced continua- tion of service by public command resulting in insolvency, constitutes confiscation Of private prOperty without due process of law. This prin- ciple was Upheld by the united States Supreme Court in the case of Brooks-Scanlon Co. v. Railroad Commission Of Louisiana, in 1920. This limiting principle, known as the Brooks-Scanlon doctrine, has become the benchmark of abandonment justice. Abandonment administration shifted to newly created state utility regulatory commissions at the turn Of the century. Guiding principles were not Changed radically from those established by state courts. Pro- tection of railroad stock and.bond holders and protection Of the public interest associated‘with a strongly viable transportation system, were given precedence over the convenience Of local railroad users in cases where railroad solvency was threatened. Hewever, the convenience of local interests, guaranteed in trade for charters Of incorporation, were protected.when continued service did not threaten the viability of rail- roads, essential tO the broader public interest. 2“Naylor v. Dodge City, Mbntezuma 8 Trinidad R.R. CO., 36 Pac. 747, 748 (1894), in Philip D. Locklin, Economics of Transportation (Homewood, I11.: Richard D. Irwin, Inc., 1966), p. 575. 27 Federal control of railroad abandonment was established with the Transportation Act of 1920. The Act represented sweeping changes in the Interstate Commerce Act Of 1887 designed to facilitate the transfer of . railroad management back to private companies following government Oper- ation during WOrld War 1. Railroad abandonment was a non-issue.25 Abandonment cases were infrequent and the future of railroad expansion was viewed with Optimism. Only one significant debate involved.appropriate division of au- thority between federal and state agencies in regulating new line exten- sions and abandonments. Abandonments and new line extensions were not treated separately and new line extensions appeared a topic of future importance. States' rights advocates feared federal commissioners would neither understand nor give "proper" protection to local interests. Federalists noted the importance Of protecting the broader national pub: lic interest. The House version of the bill included an amendment to permit federal jurisdiction only for line alterations spanning more than a single state. Such cases were rare. The Senate version provided federal authority over all route adjustments. The Senate version was adopted in Conference Committee and became law. Federal regulatory jurisdiction was outlined briefly without detail. . . . NO carrier by railroad subject to this chapter shall aban- don all Or any portion Of a.line of railroad, or the Operation thereof, unless and until there shall first have been Obtained from the commission a certificate that the present or future public convenience and.necessity permit of such abandonment.26 25Cherington, Railroad Abandonments, pp. 25-40. 26U.S. Code, Title 49, Part 1, Sec. I, par. 18 (in.part). 28 Jurisdictional authority of the ICC to regulate rail abandonments was tested immediately in the courts. The United States SUpreme Court in Colorado v. United States, et_al,, 271 U.S. 153 (1926), based its arguments on the supremacy of the broader public interest. The exercise of federal power in authorizing abandonment is not an invasion of a field reserved to the state. The obli- gation assuned by the corporation under its' charter of pro- viding intrastate service on every part of its line within the state is subordinate to performance by it Of its federal duty, also assumed, efficiently to render transportation ser- vices in interstate commerce.2 ‘With this support of the Supreme Court and the complexion of the~ Act, the ICC had the opportunity to develop a strategy of abandonment in broad.nationa1 terms. Hewever, precedent established in state ac- tions prior to 1920 and continual pressure from state Officials pre- vented this strategy from developing. The ICC developed a particularist approach to the ”public interest" focusing upon local implications Of railroad abandonment for local communities. ,The broader national inter- est was protected by continued.application of the Brooks-Scanlon doctrine as a.minimum principle and liberalization of provisions for branch line abandonments by solvent companies. The ICC warned in the Proposed Abandonment of Branch Line by Colorado and Southern Railway Co., 72 ICC 315 (1922), that It is not in the public interest that even a strong line like the applicant should.permanently Operate parts of its‘system that do not yield revenues sufficient to pay Operating expenses.28 In the later case of Long Island Railroad Company Abandonment, 166 ICC 671 (1930), the ICC maintained discretion over line abandonments for 27Cherington, Railroad Abandonments, p. 52. 28Ibid., p. 50. 29 companies of all degrees of profitability. Any unnecessary burden upon the transportation system Of the country is an unreasonable burden. While it is true that loss from operation from a portion Of a railroad system will not. in every case justify the abandonment of sudh Operation, it is also true that circumstances may justify the abandonment , of an unprofitable line notwithstanding the prosperity of the system as a whole. The circumstances Of each case must govern its disposition.29 The particularist approach was supplemented by a principle of "balancing of interests" to resolve conflicts.30 This principle seeks to balance the probable losses to the railroad through continued opera~ tion against probable losses suffered by the localpublic through aban- donment. Railroads must prove that the line under application has been and is likely to continue to be a deficit operation. Local protestants must prove their ability and willingness to provide enough traffic to clear the deficit in the near future. Early concern for local rail users was evidenced in the ICC's denial Of requests to abandon segments of the Boston and Maine Railroad. In 1925, the Boston and Maine Railroad proposed the first package aban- donment reorganization policy in history, known as the Loring Plan. Of seven applications, composing the first battery Of requests, fOur were denied. The ICC stated that Irrespective Of the origin of an existing line, people gather about it and create for themselves an interest in and a de- pendence upon it. Under these circumstances abandonment brings about the kind.of hardships with which it is difficult to deal. The sufferers in sudh cases have no redress against those guilty Of the original error.31 291616., p. 56. 30Ibid., pp. 125-136. 31Cherington, "Abandonment in New England." 30 Strict adherence to the principle of "balancing Of interests" led tO the failure of the package abandonment procedure for reorganization. Treatment of the Loring Plan induced a very cautious abandonment behavior by railroad companies. Historically abandonment applications have been granted in a large proportion of cases. Despite liberaliza- tion of the principles governing rail line abandonments , relative to those applied by state regulatory commissions, applications were ten- dered only after close scrutiny by railroad firms. After the ICC re- fused so many requests of the Loring Plan, few applications even appear- ed. The restrictive tone set early by the ICC limited abandorment at- tempts to those lines with only negligible traffic. Restrictive prac- tices in the height of economic prosperity mark the ICC's regard for local interests when railroad companies are not threatened with insol- vency. With the advent of the Depression, the ICC yielded more abandbnment decisions favorable to railroad requests. Economic conditions had changed but the principles established for disposing of abandonment cases had not changed. More cases involved incipient company failures. More application was made Of the limiting, base principle Of protecting property interests of owners and creditors and of protecting the strength Of the railroad system in the broader public interest. Throughout the history. of abandonment regulation, disposition of cases has varied with general economic conditions, but basic prin- ciples guiding decisions appear quite consistent. The Brooks-Scanlon doctrine protects the property of railroad creditors and stockholders in cases of severe financial disaster. 'Beyond this minimum the ICC has sought to balance the losses of the railroad with the losses of local 31 conmunities. Procedures for presenting each side of a case then become important . The Reiional Rail ReopLanization Act of 1973 The capital shortage problem Of railroads has been dramatized re- cently by the bankruptcy of the Penn Central Railroad and six other Northeastern railroad companies. The Regional Rail Reorganization Act of 1973 was designed to provide continued local railroad service to communities on lines of the bankrupt roads. This act implies no major discontinuity in basic principles of abandonment justice, but does imply a shift in emphasis of public control, which may result in significant changes in the distribution Of rights and responsibilities. The de- partures from established procedure implied by the Act have been incor- porated in more general legislation, which would apply to the entire nation. The Regional Rail Reorganization Act of 1973 has been established to remedy an inmediate problem. Two new corporations have been estab- lished to maintain essential service to customers of financially torn railroad companies. The United States Railway Association (USRA) is a nOnprOfit government corporation charged with the responsibilities of designing a regional railroad system plan and distributing aid and loans to states and local transportation authorities for subsidy or purchase of operations not included in the system plan. The Consoli- dated Rail Corporation (CRC) is a for—profit common carrier established to acquire and operate railroad properties of’ bankrupt companies, which are considered essential. 32 The final systan plan will identify rail lines Of cornpanies in re- organization tO be continued in service. The lines may be purchased by the CRC or by existing solvent raierads in the region. The plan will also specify those properties which are of value for public uses other than transportation, such as recreation. Lines designated as nonessen- tial will be abandoned if railroad users, commmities and states fail to purchase the line or subsidize Operation. The Brooks ~Scanlon doctrine remains the limiting principle, of aban- domnent justice. Neither railroad companies nor creditors will be forced to continue Operations with financial losses. Nor will individuals be forced to relinquish property without compensation. The shift Of emphasis implied by the Act places greater weight upon the national public interest and less On local public interests, than has been practiced previously. As the Supreme Court and the ICC estab- lished early in this century, the nationalpublic interest lies in main- tenance of a strong, efficient transportation system. However, imple- mentation of an abandonment regulatory policy emphasized the balancing of local public effects and railroad financial effects Of line closure. At this time Of regional system crisis, the Act calls for closer atten- tion to the broader national interest, subordinating local concerns to a secondary position. Previously, the balancing Of interests approach to adversary pro- ceedings required both conuntmities and the railroad to bear the burden of proof in argumentation. However, the railroad bore the financial burden. When a local public interest was determined to warrant contin- ued service, railroads were'ordered to continue such service .wholly at railroad expense. Under rules established by the Act, both disputing 33 parties continue to bear the burden of proof, but financial responsibil- ity for continuation of potentially unprofitable Operations has been shifted to the railroad user. The new rules provide a.market test of local willingness and ability to pay for continued railroad service, given the existence of various transport alternatives. During the first two years of transition states, local communi- ties and regional transportation authorities will be eligible for federal financial and consultation assistance. Up to 70 percent of Operating losses incurred by local railroad enterprises may be Offset by federal rail service continuation sUbsidies. Where operational sUbsidies are not requested, federal sources may provide 70 percent loans for local purchase of lines and 70 percent loans or loan guarantees for repair or restoration of acquired properties. Consultation assistance to de- termine the level of subsidy required for solvency may be requested of the Rail Services Planning Office of the Interstate Commerce Commission. The shift of financial responsibility for continued local railroad service to local agents has created requirements of investment decision rules regarding branch line Operations. Local communities must be able to determine their own willingness to pay for a level of continued rail- road service and whether this willingness is sufficient to attract the level of service desired. The next three chapters are devoted to deter- mination of the boundaries of market and public provision of local rail- road services. CHAPTER III THE MARKET BOUND -- SUPPLY Railroad companies are highly couplex producers of transportation services operating simultaneously in a market and an administered environ- ment. Despite the influence of regulation, the market continues to Offer assortments of variously valued Opportunities requiring decisions regard- ing allocation Of scarce resources. Abstraction from administered rule making will allow observation of the direction and magnitude Of market forces influencing economic decision making. This amounts to viewing regulations as a set Of limiting rules within which the will of manage- ment is recognized. The objective of this and the next chapter is to develop a set Of market bounds established by the behavior of direct market participants and by technical constraints, assuming no administered restraints and no responsibility for external effects of resource use. The bounds of supply in this market are shaped by technical limitations of the produc- tion function and by railroad cost structure which, in turn, is influ- enced by sellers and competitors in factor markets. The bounds of de- mand are shaped by the denand and supply of comnodities to be moved and by alternative Offerings of, substitute and complementary transportation services. Each side of the market will be treated separately, at first, 'then integrated to establish the complete market bound to provision Of service on particular railroad lines. 34 35 Railroad firms have long served to exemplify new twists in produc- tion theory, due to their fascinating array Of unusual economic charac- teristics. These same Characters require application Of a ridh set Of theoretical principles as guide tp a solution Of the railroad line dis- investment problem. various elements of theory will be applied to rail- roading, all of which serve to build appropriate investment-disinvestment decision criteria applicable in practice. Outputs, inputs and their re- lationship will be explicitly defined and related to cost relationships and notions of rail plant capacity. Synthesis of two complementary approaches to the interaction of production and investment will serve as the ground for development of roadway investment-disinvestment cri- teria. jMeasures will be developed for the magnitude of subsidy necessary to neutralize market forces for continuing desired operations lying beyond the market bound. Finally, a crude supply relationship fer a range of product prices is considered to test the potential power of alternative pricing policies and.private collective action in creating railroad revenues. ‘Multiple Outputs Outputs of production are best defined in relation to the percep- tions Of consumers. IMarketable products Of tranSportation firms are the time and place utilities injected into people and commodities which consumers perceive as having positive value. Consumers discriminate between these utilities as they are associated with different commodi- ties and different origin and destination locations. Haney described this notion earlier. [Commodities] differ in demand, both in kind of demand and in lo- cation Of demand. (a) COmmodities differ in their capacity for 36 receiving additional utility through transportation, as is well- known to be the case as between "low grade" goods such as sand and "high grade" goods such as glass ware -- the one does not "stand transportation" as well as the other. (b) Conniodities also differ in the location Of demand, being valued in differ- ent markets.1 Consequently, railroad firms which haul more than a single commodity or service more than a single pair of locations are producers of multiple products. The notion ,of homogeneous products, typically assumed in sin- gle product production theory, must be altered. Multiple product production has important implications for firm production and marketing behavior. Identification of multiple output characteristics is required for selection Of appropriate theoretical tools. Multiple product production may be mistaken for joint production or for simple product differentiation. Joint products imply an inevitable simultaneity in the technical production process. Classic examples Of joint products are wool and mutton, and steel and smoke. Whether valued positively or negatively, each secondary product is fonned as a "by- product" in the creation of the primary item. Joint products are tech- nically interdependent. Differentiated products tend to be similar outputs which require a deliberate decision to modify the nature, appearance, or 'image of arti- cles to capture the interests of different groups Of consumers. Differ— entiated products may be technically independent with branching of pro- duct lines typically initiated late in production proceSses. The distinc- tion between multiple and differentiated products is subtle. The two differ only as a matter Of degree and have no clear point of demarcation. 1Lewis H. Haney, "Joint Costs with Especial Regard to Railways," fiarterly Jpnrnal Of Economics, 30 (February, 1916), 235. 37 Multiple products differ from one another in their unique relation- ship to commodity markets. Multiple products are technically independent and bear no necessary relationship to one another, in use. Carriage Of grain and automobiles may be accomplished simultaneously by the work of a single engine on a single track. However, there appears no reason grain hauling could not be accomplished without the movement of auto- mobiles, as evidenced by unit train Operations. Similarly, transport of grain from one location is not dependent upon grain movements from other locations. The decision to produce each railroad produCt of carmodity and location characteristics must be made explicitly. Production of multiple outputs in the presence of a single set of durable resources requires a theory which permits application of durable inputs to more than a single output. Clemens explains the motivation behind multiple output production. What the firm has to sell is not a product, or even a line of products, but rather its capacity to produce. Any idle piece of equipment, any unused technical knowledge or organizational resources possessed by the firm represent a challenge to the sales force and production manager. market reasonably accessible to the firm in which price 15 greater than marginal cost constitutes an invitation to invade. It is not necessary that the market be related to the firm' 5 existing ones, although in view of management's experience it is desirable. Existing durable factors constitute this "capacity to produce." Durable inputs are not consumed in a single production period. When a portion of these inputs can be transferred between production processes, intrafirm competition is established between product lines for use of the set of stock resources. Too, there exists a possibility for 2E1i W. Clemens, "Price Discrimination and the Multiple-Product Firm," Review of Economic Studies, 19 (1951-1952), 2 38 short-run excess capacity with best use of resources to fulfill manage- ment Obj ectives. 3 Production and investment theory applied later im— plies excess capacity in the longer term is not inconsistent with best use of resources. Consequently, excess capacity in itself is not a suf- ficient condition for disinvestment. Considerable specificity in defining railroad outputs will be main- tained. Composite products grouped by commodity type and by common origin or destination location are constructed to permit distinction of service to groups of similar commodities on a single roadway segment. Irputs and Cost Relationships Multiple output production implies use Of a set of inputs at least a portion of which are not fully consumed in a single production period. Railroad inputs and cost relationships will be discussed together since the technical characteristics of each resource bear heavily upon the type Of cost relationships management must deal with. First, a dis- cussion of railroading as a decreasing cost industry will be directed toward placing this characteristic in perspective with time and levels of output aggregation. Secondly, inputs will be approached as inter- dependent units Of resources with various degrees Of durability. Short and long run time periods are abandoned in favor of variable lengths of run. Understanding the economic characteristics of each resource will allow development of a production function for railroading which con- siders the importance Of' various durable inputs. 3Ralph W. Pfouts, "The Theory of Cost and Production in the Multi- Product Firm," Econometrica, 29 (October, 1961), 651. 39 Increasing and Decreasing Average Cost Relationships between railroad cost and output depend upon the dimensions Of time and product aggregation inherent in the definition Of output units. Different output units are associated with different sets of avoidable or variable costs. In the short term when roadway plant and equipment stock are fixed, aggregations Of tonemile outputs may be defined in units Of carloads or trainloads Of service to particu- lar commodity groups on particular lines. In the longer term when road- 'way plant and equipment stock are variable, an aggregation of tonemile outputs may be defined in units of branch line enterprises. The choice of appropriate output unit to use in analysis depends upon the question to be resolved. For questions relating to private or social investment in branch lines, the branch line enterprise unit is applied. .A.brief digression on cost functions related to the various output units will help to place the notion of railroading as a decreasing cost industry into perspective. I .Addition of one more car to a sdheduled train.may-give rise to a small incremental cost. As long as power equipment and roadway re- sources used.ck>not strain their respective capacities and an additional crew shift is not required, shadow prices Of these resources are zero for the decision whether to service an additional carload unit. The marginal carload cost amounts to the opportunity cost Of using movement equipment in the intended service and individual car handling charges incurred. The decision to add one more train to an existing railroad line must be evaluated with a.much broader set of variable costs. ‘Mar- ginal trainload cost includes Opportunity cost of power equipment and 40 operating capital paid in labor and fuel, as well as Opportunity cost of movement equipment . In the short term, where existing power and movement equipment is underutilized, marginal cost of these resources is equal to their zero shadow prices. Incremental roadway expense is very small for passage of additional cars or trains. If the railroad firm experiences shortages of equipment or Operating capital, added cars or added trains are pro- vided at higher and higher marginal Opportunity cost. The relationship. of marginal cost to output depends upon the supply of the "bottleneck" resource. Rapidly rising marginal cost may be caused by equipment short- ages even in the presence of excess roadway capacity. Unavoidable roadway expense per carload or trainload unit, in the short run, is quite large at very low levels Of traffic volume on branch lines. This average unavoidable expense declines continually as traffic output increases. Whethermarginal cost lies above or below average cost is a matter for empirical resolution. The answer depends upon the level and rate of change 'of both average and marginal cost rela- tionships . Using aggregate firm data, Lorenz has demonstrated that fuller utilization of existing roadway facilities causes decreasing average costs in railroad production.l+ An inverse relation was discovered be- tween Operating expense per gross tOn-mile and gross ton-miles per mile, of roadway, for a cross section sample Of railroad firms. The relation- ship does not describe directly the branch line average cost function. 1“M. O. Lorenz, "Cost and Value of Service in Railroad Rate-Making," Qiarterly Journal of Economics, 30 (February, 1916), 216-219. 41 First, accounting procedures exclude measurement of equipment shadow prices. Secondly, data represent cost averages over entire firm.opera- tions, including both mainline and.branch line Operations. .Also using aggregate firm.data on railroad costs, Borts has pro- vided some evidence that marginal cost Of carloads sometimes lies above and.sometimes below average cost.5 Estimates Of railroad cost as func- tions of car miles and average length of haul per car were made for three firm size classes and three regions. While holding length Of haul constant, carload marginal cost for large firms is greater than that for small firms, though the difference is not significant statis— tically. For Eastern railroads elasticity of cost.with respect to car- loads is predominantly greater than unity, that is, costs increase pro- portionally faster than output, evidence of increasing average cost. Finally average costs evaluated.at mean carload levels within each finm size class are higher for larger firms and lower for smaller firms, in- dicating that minimum attainable carload.unit cost for large companies is higher than for small firms. In several instances measured.marginal cost lay above measured average cost, in.the East. In the west, de- clining average cost and increasing marginal cost Of carloads is notable. Both marginal and average carload coSt relationships are falling as out- put increases, in the South. Borts' results cannot be used directly to make inferences about branch line cost fhnctions. Borts' procedure, like that of Lorenz, does not account for equipment shadow prices and aggregate firm.data used represent averages of mainline and brandh line costs.’ 5George H. Borts, "The Estimation of Rail Cost Functions," Econo- metrica, 28 (January, 1960), 108-131. 42 In the longer term when roadway plant and equipment stock become variable, one Observes the incremental cost associated with additional branch line enterprises. A firm operating with excess equipment, man- agerial or financial capacity may maintain Operations On a line with very low marginal cost. However, as capacity tightens, allocation of resources to the branch comes at increasing marginal Opportunity cost of capital, management and equipment. Operating and investment capital must be Obtained from ever more erpensive sources. Management gives attention to the marginal branch at the expense Of attention to other branch enterprises. As equipment utilization approaches capacity, rail- road cars and engines are placed in service to the marginal branch at the expense of potential traffic generations on other branch enterprises. Financially insecure railroad firms with shortages Of capital likely Operate with increasing marginal cost of branch line enterprises. Though this presumption requires empirical verification, increasing long term marginal cost for branch line enterprises is assumed. Resource Durability and Cost The structure of costs within the railroad firm is marked by diverse input durability. In the economic sense, cost is the value of feasible alternatives foregone as a result of resource use decisions. Once de- cisions are made and implemented, the entire set of alternatives open to the firm is altered in dynamic interaction with the environment. W. A. Lewis has developed a useful dichotomy of costs which permits dis- tinction between what are commonly called fixed and variable costs.6 6W. A. Lewis, "Fixed Costs," in Trans ort, ed. by Denys Munby (Baltimore: Penguin Books, Inc., 19685, pp." 61-97. 43 Costs are classified as escapable and inescapable. Given technical, institutional and.market characteristics of individual inputs, degree of escapability is dependent upon time. For firms with numerous dur- able inputs Of varying degrees of escapability, the notion Of long run is rendered incapable of serving finm production and investment analysis. Interdependence Of multiple durable inputs implies that as the life of any one element expires, the entire structure of assets will be affected. This suggests formation of an investment-disinvestment decision model which jointly treats all resources affected by a decision. Costs which are wholly inescapable are not as prevalent as commonly imagined, though Lewis explains four categories of cost which cannot be avoided. (a) some are inescapable in the Short run but not in the long (b) :33; are joint costs, and inescapable only in that sense; ' (c) some are inescapable for small but not for large changes of output; and (d) some are inescapable in all senses.7 Each category of railroad inputs will be discussed in relation to one. or more of these descriptions, for only avoidable costs are relevant to the capital adjustment decision.process. The first type of unaVOidable cost is that for which cost escaped currently may not be as great as cost escaped later. The decision.pro- blem becomes one of assessing immediate and ultimate savings in an en- vironment of continually changing Opportunities. Resources described in this category are contracted inputs and investments in durable assets . 7Ibid., pp. 62-63. 44 Costs of contracted labor and fuel are to a degree inescapable short of contract eXpiration. Contract negotiation and Congressional action have made labor a durable resource. Resource saving mergers and abandonments have been effected at the costs of severence pay and relocation of affected workers. Only in the longer term, as workers reach retirement age, or an age at which early retirement is advanta— geous to both employee and employer, are these labor costs avoidable. Costs associated with physical assets vary in degree of escapability over time. Some 'of the costs may be escaped iJmnediately. Costs of operation can be escaped by not using equipment. Costs of ownership may be avoided through sale or salvage. However, if the present value of the equipment in operation, considering risk, is greater than the present value of operating costs and salvage value, currently escapable cost will not be as great as that avoided later. Most equipment and facili- ties are described in this manner. Railroad cars and engines, once purchased, may be put into service, sold, or kept in reserve. Costs of Operation are escapable by disuse. Ownership costs are avoidable to a degree equal to salvage value. The same is true for building, terminal, traffic control, and roadway facilities. Each has a life unique to its technical nature and its salvage market, both of which are dynamic. Joint costs, are incurred by simultaneous use of a resource in production. These costs are not Hescapab'le by eliminatingproduction of one product, for they continue with production of the other. Power units and movement units are separate. One engine may serve dozens of cars. Once a train is formed, marginal cost of adding another car may ‘ be small and the sun of the marginal costs does not equal total cost of owning and operating the engine. Emenses of ownership, maintenance and 45 personnel cannot be allocated in proportion to ton-mile outputs. Back hauls may be treated similarly. 7 When equipment runs on a branch between points A and B with uneven traffic, the added cost of carriage in the direction of traffic deficit is small, unless opportunity cost of equip- ment makes faster, empty returns more attractive. ‘ Joint costs may become assignable to product groups where not identi- fiable by individual products. Collecting products by conmon origin or destination locations defines the group of railroad products originated or terminated on a particular branch line. On branches where overhead traffic is not present or where such traffic can be rerouted, full road- way, structure, and personnel costs are identifiable to the composite product. A portion of equipment rents and fuel expenses are also identi- fiable. To the extent that joint costs are allocable to products, they are escapable. Lewis' third category of inescapable costs is similar to joint costs. There are some costs which cannot be allocated because they are indivisible. Indivisible costs differ from joint costs in that the form- er does not require simultaneous use of durable resources. Roadway, engines, cars, and freight stations may be used for various movements separately, such as, for composition of different trains at different times. Still, expenditures on these resources will not vary directly with ton-mile outputs. Marginal cost of using a freight car one more time or running over aatrack one more time may be small. Buildings and many parts of roadway impose indivisible costs as each deteriorates with time rather than in proportion to ton-mile outputs. Buildings age as rapidly on light density branch lines as on mainlines. Railroad ties and fences succumb to natural forces with time rather than 46 traffic. Snow and sand removal are random expenses. Of the entire roadway only steel rail and joints deteriorate in a reasonably direct way with traffic volune. For example, the Interstate Cannerce Commis- sion attributes just fifty-seven percent of total maintenance expendi- tures, for running track, as a traffic related expense.8 Earlier, Acworth crudely estimated traffic related maintenance expense at about forty percent.9 Indivisible costs amount to the difference between total cost and the sun of output times marginal cost. Indivisible costs are described as inescapable for small but escapable for large changes in'output. This means that reductions in train frequency and abandonment of branch oper- ations are ways to escape indivisible costs while a single shipment order has no impact on indivisibles. Lewis notes that "whatever the indivisi- ble unit, if the expenses attributable to it are escapable they must be covered if the unit is to be maintained."10 This is to say that when opportunities arise to escape the expenses commonly thought of as fixed, revenues must cover such costs to keep the indivisible unit in service. Expenses and revenues attributable to an indivisible unit must be considered in relation to the entire firm operation, not just those ‘ identified directly with the unit. Nove suggests the existence of in'-' temal economies as justification of cross-subsidization of enterprises 8Interstate Commerce Commission, Railroad Carload Cost Scales by Territories for the Year 1970 (Washington, l).C.: Tnterstate Commerce Comission, 1973), p. 200. 9W. M. Acworth, The Elements of RailwaLEconomics (Oxford: The Clarendon Press, 1905), pp. 34-35. 10Lewis, "Fixed Costs," p. 66. 47 within transportation firms.11 According to Nove, one segment of road- way may be able to subsidize unprofitable feeder lines for traffic col- lection services provided. However, this approach isolates emenses and revenues to trackage units rather than traffic units and complicates the accomting procedure. Freight rates are charged to traffic units. When ton-mile traffic units are aggregated across commodities hauled to and from a common roadway link, the branch line enterprise is defined . as a traffic unit for purposes of expense and revenue accounting. Ca1- culation of both on-branch and off-branch expenses and revenues com- v ’ pletely describes the influence of a particular branch line‘on an entire railroad company system. The final category of inescapable costs are those which can never be escaped. These costs' are related to items which are perfectly per- ishable or permanently durable and for which there exists no salvage market. Acworth provides a colorful survey of the resources used in developing roadway. Before rail can be laid rough surveys of alterna- tive routes and intensive surveys of the selected route, legal negotia- tions with landowners and local authorities, and buying of land and pay- ing of damages to adjacent land holders, are preliminary. The embankments and cuttings, the tunnels and viaducts, the bridges and platforms, the culverts and ballast, all are fixed to the spot forever. If the railway is a failure, they can never serve any other purpdse where they are, not be taken up and employed elseWhere.1 These costs are variable prior to investment and are important to the investment decision. Once the investment has taken place, these costs 11Alec Nove, "Internal Economies," EconomicJournal 79' (December, 1969), 847-860. 12Acworth, Railway Economics, p.. 12. 48 are considered sunk costs and play no role in further investment or dis- investment decision making. Treating time as a continuu‘n and multiple durable inputs as inter- dependent in production processes requires reassessment of: all produc- tive assets when a single contractual conmitment or the life of a single asset expires. As one moves from the inmediate production period to longeratime frames, the definition of "fixed" becomes hazy as part of costs remains inescapable and part becomes escapable through salvage or disuse. These notions become important in development of a suitable production ftmction including durable resources and in development of investment-disinvestment criteria. Production and Investment The decision by a railroad firm to abandon a right-of-way is a cap— ital adjustment decision affecting long range production. The foregoing description of interdependent cost relationships requires production and investment-disinvestment functions which consider the continual interaction of all variable and durable resources. Conditions leading to contemplation of capital adjustment imply some discretion by manage- ment to vary‘ stocks of durable inputs . A model allowing both flow and stock inputs to vary is needed to represent the relationship between production and investment. Brief development of a production-investment model will guide development of inves ment-disinvesunent criteria for branch lines . 49 Vernon Smith has developed a stock-flow production function con- sidering inputs of all degrees of durability.13 Snith dismisses the capital service flow approach of converting stock assets into flow inputs on current account. Rather, output varies with the physical quantities of durable assets present in the production process. Durable resources are those which add value to the production process by their very "presence." The stock-flow production function represents the highest level of output obtainable with applications of different levels and mixes of variable and durable inputs. For the moment assune a firm produces one output, y, with use of one variable and one durable input, x1 and X2, respectively. Express the firm's production function as y = f (x1, X2). Stock-flow production functions have been criticized severely for implicit assumptions of constant rates of utilization of duraqle inputs. Smith recognizes the potential for substituting durable factors for variable inputs, but explicitly disregards the substitutability of more intense use of a capital good for marginal increases in its stock, for lack of empirical support.“+ Idachaba argues that'rates of utili-, zation of stock resources may act as substitutes for additions to these stokks.15 This implies a production function of the form y = f (x1, X2, 62) where 02 is an index of capital service flows from marginal changes in the rate of utilization of durable factoer. Input price 13Vernon L. Smith, Investment and Production (Cambridge: Harvard University Press, 1961), Chapter 3. f 1‘*Ibid., p. 66. 15Francis Sulemanu Idachaba, "Rate of Use, Investment and Disinvest- ment" (paper presented in the Department of Agricultural Economics, Michigan State University, 1972, Mimeographed) . 50 attached to 02 is the user cost associated.with varying rates of utili- zation. The apprOach of Idachaba makes development of empirically useful production-investment models unnecessarily difficult. Measurement of user cost remains a diffiCulty not yet overcome in regard to railroad durable inputs. Paucity of measurement techniques is notable with con-. tinued application of highly complex cost allocation schemes perpetuated by Interstate Conmerce Commission accounting methods. Investment.models are consulted.previous to capital installations or liquidations. Consequently enterpreneurs will be making dbmand fore-' casts based.upon.varying quality of information about the future. De- finition of stock inputs and associated costs may be made to conferm 'with one or a combination of rates of output assigned to the various por- tions of the time horizon. .A single type of capital good may be defined with characteristics of different output rate and different length of life, as often done in programming techniques. For example, one may use the production function y = f(x1, X2, X3) where X3 is the same maChine as X2 but used at a different constant rate. .Alternatively, if’afiprdba- bility distribution of future demands exists, a mean rate of utilization may be applied and the best input.mix:may be selected accordingly. If the decision.maker is completely uncertain about the future, he may wish to select a stock of highly flexible durable resources. As long as a mean rate of utilization or a level of insurance through flexibility is understood, rate of use of stock resources need not be entered as a distinct input. Idachaba's argument is useful to modify the approach. to investment.modeling to allow substitution of rate of use for stocks of a physical input. 51 When planning the proper input mix one must have information on costs of resources and demand characteristics . With fixed output, the firm may wish to minimize cost; if output varies to meet demand the firm may wish to maximize profits. Assune a cost function rWzXZ C=wx + 11 l-efi' rW o o o o 2 o u where W1 15 the price of variable 1nput x1, and lTe-rrT 15 the discounted depreciation cost of 'a durable good originally priced at W2 where r is the opportunity cost :of capital and T is the planning horizon. Also assune a constant value of capital through time, that is, Egg-)- = 0 where t denotes time .' With demand p = g(y) a profit maximizing firm accepting constant prices will seek to obtain an output mix maximizing profit II=py-w1x1-:Zv-z-)_(—IZT. l-e Setting first order conditions equal to zero fif‘Pfl'w1=° rW 6H _ _ 2 = 52'2""pr 1_e-r'I' 0 where f1 and f2 are marginal products of x1 and X2, reSpectively. These conditions imply a marginal rate of technical substitution between vari- able and durable resources of 52 revealing that longer planning horizons tend to favor a greater propor- tion of investment in durable resources. Solving first order conditions simultaneously, one can obtain derived demand functions for each resource of 1 = x1 (p ’w1 ,w2 Dr’T) X I 2 _ chpswl awzoraT) - Allowing the planning horizon to be fixed by management and assan interest rate is determined exogenously to the firm, the two derived ; demand equations can be solved for the two unknown levels of irmuts x1 and X2, with knowledge of input prices, w1 and W2. Once capital resources have been installed, the stock-flow model is of no use since durable factors are no longer variable. If demand 1 increases calling for output above capacity, a similar production func- tion is constructed for consideration of plant expansion. The eman- sion function will differ from the former model in being conditioned by previous investments . The new function may appear as y = htx1.x3Ix3) where X3 may represent increased rate of output. of current stocks, ad- ditional production lines, or completely new facilities. Also once capital resources have“ been installed, decreases in dur- able assets are not possible without returning to a stock-flow produc- tion function for guidance toward best disinvestments. Contractions, too, are conditioned bytprevious investment :actions. Smith. discusses dis investment in quite a different context than investment, however. While investments may occur in increments as demand increases, 53 disinvestments are considered appropriate only when marginal revenue product for the durable resource falls to zero , when maintenance costs are assuned away. Smith concludes, therefore, that optimal investment planning may lead to over-capacity as danand shifts away from the sub- ject product. 15 Johnson and Quance modify the stock-flow approach with inclusion of the salvage alternative.17 The same production and cost ftmctions may be employed. Investments and dis investments are again conditioned on previous investment actions. Assuming a salvage value, Piz, for the durabie input exists somewhere above zero and the cost of acquiring still more of the durable factor, sz, lies above salvage value, that is, 2 2 the firm will seek to adjust durable assets in a mannerto maximize net gain, G, relative to the current position. This model is quite similar to a partial budgeting approach in that only those factors 'which are affected by a possible change are considered. The gain function wars as G=pty-y°)-acx2-x;> Where the first term on the right represents the revenue generated or lost by the change in output resulting from capital adjustment and the second term depicts changes in cost. When (X2 - X3) > 0 net additions 16Smith, Investment and Production, p. 15. 17Glenn L. Johnson and C. Leroy Quance, The Overproduction Trap in U.S. égiculture (Baltimore: The Johns Hopkins University Press, 1972), pp. -, , - 96. . ‘ 54 . are made to durable factors and a = P? , the acquisition price. When (X2 - X3). <0 disinvestment occurs. and a = P3 , the salvage price. The presence of a double negative sign makes total? salvage income a positive value. When (X2 - X3) = 0, no adjustment of resource X2 is undertaken implying the factor holds a, value in production greaterethan salvage price but not great enough to warrant acquisition of more of the capital good, that is , Gain is maximized subject to inequality conditions specifying that the final stock of asset applied be a positive quantity and that no more of the factor be sold than what is originally on hand. Johnson and Quance, too, conclude that optimun investment behavior can lead to overcapacity as long as salvage and acquisition prices of capital goods diverge . Though demand shifts may prevent entrepreneurs from realizing returns covering full initial costs of durable factors, these items will be employed in the firm as long: as marginal revenue ' product is greater than salvage value. Implications are that firms make ready supply responses to increasing demand conditions, but insuf- ficiently contract in the face of demand decreases. K Investment-Disinvestment Criteria The Johnson—Quance gain functidn and Snith's stock-flow production function conditioned by previous investments are nearly indistinguishable: The form of the gain function is moSt convenient for treating just those factors affected by capital adjustments . Assune railroad management seeks to maximize net revenues over a specified time period. Assune also 55 that the railroad firm was established years. ago and is currently pro- ducing transportation services with a stock .of physical plant and equip- ment. ‘ Though management is assumed unconstrained by regulation, prices will be assumed fixed for now. The railroad production function relates five composite inputs to the output of numerous transportation products. Outputs, are aggregated by commodity type and common location of either origin or termination. Inputs include labor, L, fuel, F, railroad ca‘rs, C, engines, B, and . roadway with associated terminals and control systems, R'. The productien function for transporting commodity 1 either to or from railroad station k is yik = f(L,F,C,E,R) where y represents ton or ton-mile quantities of railroad service. Any perceptible change in relative output or input prices will cause management to review its stock of plant and equipment for appro- priateness in meeting the firm's objective. Adjustment may take place by acquiring or selling cars, engines, or roadway capacity. Opportuni- ties for net gain through capital adjustment appear as where P ik = Discounted unit operating surplus of transport service to commodity i to or from location k (dollars/ ton) , S6 (yik - ygk) = Change in annual quantity of service rendered for commodity i at station k (tons), Psv, 'v = Salvage and acquisition prices of railroad car 3 3 type j, vintage v (dollars), ij = Number of railroad cars‘type j, vintage v (units), , Pgw, ew = Salvage and acquisition prices of engines 0f power and type e, vintage w (dollars), E ew = Number of engines of power and type e, vintage w (units), Ps_k, +k" PL k = Salvage, acquisition, and liquidation prices of Y Y ‘ Y roadway of capacity y, to station k (dollars), and Ryk = Presence of roadway of capacity y to station k. The gain model allows for sale of old or obsolescent equipment and ac- quisition of new, simultaneously. Railroad firms may consider abandon- ment of one rail link while comtemplating an extension elsewhere. Some salvage prices may be zero and some acquisition prices infinite where markets do not currently exist. The first term of the gain function, E g P ik (yik - ygk), defines the difference in net operating revenues attributable to sales of trans- portation services before and after capital adjustment, discounted over the planning horizon. Depending upon the net effects of capital adjustment tpon traffic generation, this term may be either positive or negative. The second and third terms of the gain equation, 2 Z P and S jv ij J v 2 Z ng ij, respectively, represent salvage and acquisition Opportuni- J V ' ties for the many kinds of cars of different ages. The Interstate Com- merce Commission reports operating costs for seventeen railroad. car 8 types. Salvage price, Pjv’ may be the value gained either from sale of cars or from reduced equipment maintenance standards . An example of the 57 latter is suspension of tight door and floor maintenance on boxcars , necessary for grain.shipment but not essential for general cargo._ Simi— larly, aoquisition.may reflect the cost of modifying car service char- acteristics as well as buying new or used cars. Net gains from salvage and acquisition of motive power units, g gpzwfiew and gngwBew, respectively, are similar in description to railroad car adjustments. Salvage and aoquisition.prices may repre- sent engine modifications as well as sale or purchase. These prices may also reflect the discounted cost of fuel consumption of each alternative over its planned life. Rate of fuel consmption has many determinants. Where an engine is destined for use in a particular region with a.pre- determined.mean train size, engine types can be compared for fuel use. The term.£ Z PE-k Ry-k represents net gain obtainable by reducing roadway capacityyfrom v to y- on the segment leading to station k in the direction of the terminus. Capacity reduction.may be achieved by various means. Signal systems may be salvaged, reducing speed and train capa- city. Sidings and other than main tracks may be removed and materials sold for scrap or reused elsewhere. ZMaintenance standards may be re- duced allowing the quality of track and roadbed to deteriorate. Neglect- ing maintenance results in depreciation.and maintenance cost savings, in trade for increased costs of operation due to slower traffic speeds and.more frequent derailments. The gain from all capacity reduction is the sum of discounted net gains from sales of auxiliary facilities and maintenance cost savings, summed over all links being adjusted. .Aoquisition cost of increasing roadway capacities from y to y+, E Z Y+k Ry+k’ represents cost of adding auxiliary facilities, increasing y+ 58 maintenance standards , and acquiring new rights-of-way. Acquisition prices of the latter are considerably higher than salvage prices due to the high, permanently inescapable costs of surveying, cutting and clearing land, and legal transactions. The final term of the gain function, E Pick Ryok’ represents the net value to the railroad firm from liquidating a segment of roadway already of minimum capacity, yo. Salvage alternatives include sale of an enterprise to another firm with intentions to continue operations or dismantling physical structures for separate sale. In a narrow sense the railroad firm seeking to abandon a line may be indifferent to dis- integration and sale as a short-line operation. In a broader sense of regional transportation service demand, decision makers may discriminate. Where traffic from the abandoned line is likely to be diverted to another station on that company's lines, physical disintegration may be preferred to avoid forfeiture of origin-termination charges to a short-line opera- tion. Where traffic from the abandoned line is likely to be diverted to another mode, sale as a short-line may serve to retain a portion of freight revenues . Total liquidation price, Ptok’ is the present value of saving all costs associated with the presence of the rail line, independent of traffic. Costs associated with traffic may be avoided by not operating trains; costs associated with roadway may be avoided by abandonment. Roadway liquidation price may be defined by the following identity. PLk és+T+ .43M-J Yo where S = Salvage value of land, track, and structures less dismantling cost, 59 T = Discounted present value of _a_d_ valorem taxes, M = Discounted present value of maintenance of way. and structures eJcpenses , and J = Discounted present value of rental income from joint trackage rights and use of pole, ground, and air space. Total maintenance expenses are multiplied by the constant 0.43 to repre- sent only the component of these costs notrelated to traffic. This constant was issued by the Section of Cost Finding of the ICC's Bureau of Accounts, resulting from a five-year, cross sectional analysis of expenses of all Class I line-haul railroads for the period 1966-1970.18 Maximization of the gain function is subject to several constraints of feasibility. Post adjustment resource stocks, denoted with absence of superscript, may not exceed original stocks less the amount salvaged, plus the amount required. No more of a resource may be salvaged than originally held in stock. These restrictions appear as CD .0 c.-c.+c‘.‘ c. J J>'J “£2 (DU) U .V ['11 o Be-E W w I W x. I _<'7~'1 w + .V 7U yk 18Interstate Commerce Commission, Carload Cost Scales, p. 200. 60 The nature of mmltiple output production and the inclusion of liquidation alternatives require an optimizing technique which will treat inequality constraints and boundary solutions . The conventional Lagrangian multiplier technique is limited to interior solutions imply- ing no specialization in production and no liquidation alternatives . Application of the Kuhn-Tucker theorem will provide a set of necessary and sufficient conditions for maximizing the gain function. Demonstra- tions of the technique as applied to firm production and cost problems have been performed by Pfouts for cost minimization and by Naylor for profit maximization.19 ‘ Naylor's explanation of Ktflm-Tucker conditions for maximization will be summarized before application to the railroad capital adjustment gain function. The Kuhn-Tucker theorem is a tool with which to find extreme values of a function such as g = amp-H.390) subject to constraints which may be either equalities or inequalities, as hICX1,...,)gl):0 r=l,...,q For a maximization problem one assumes the objective function and con- straints to be concave to the origin and differentiable. Minimization requires convex, differentiable functions. Further, maximization requires that the Lagrangian expression L(X,).) be a concave eXpression of X at any particular value of A and a convex function of A at any value of X. 19Ralph W. Pfouts, "The Theory of .Cost and Production in the Multi- Product Firm," Econometrica, 29 (October, 1961), 650-658. Thomas H. Naylor, "A Kuhn-Tucker Model of the Multi-Product, Multi-Factor Firm," Southern Economic Journal, 31 (April, 1965), 324-330. 61 The latter assutption guards against a single point appearing on the frontier of the constraints . First a Lagrangian form of the constrained objective function is formed as q gCXi) + Z ArhrCXi) L(Xi, Ar) = r-l xi>_o i=l,...,n Argo r=l,...,q It is both necessary and sufficient for existence of a maximum that a saddle-point exist at the extreme value of L(Xi,>.r). The Kulm-Tucker theorem states that under the above conditions, for a saddle-point to exist, the following necessary and sufficient conditions must hold. (211%. 0.50 i=1,...,n 1 _ Xi-Xi n 6L 2 KY. .x‘i’=o 1=l 1 ngo i 1 X210 1=l,.,n 6L 3‘)" >_0 r=19 :q r A =A° r r n 2 %%- - A: = 0 r=l r A =>\o r x°>_o r=l, ,q 62 The first condition produces a "corner" solution.when the inequal- ity holds, that is, no amount of X1 enters the solution in.the presence of the inequality. 'Variable X.i does enter the final solution when.the equality holds. The second condition is an either-or statement showing that either the best amount of X1 to include is zero or a quantity con: sistent With the marginal conditions of the Lagrange expression. The feurth condition assumes the equality only‘when the assoCiatedfconstraint is limiting. Conditions three and six require non-negative quantities of all variables and.multipliers. Applying the procedure to maximize the railroad capital adjustment gain function, the following Lagrangian expression is fonmed. _ - o S L ‘ E g Pik (yik yik) + 32‘;ij ij 42114 (3. +2sz E -mpA E j v jv jv e‘w ew ew e‘w ew ew s L + ZP_R_-£ZPA R +£p R E y- Y R Y R Y, r+k r+k yok yok + HOM Aj (C9 - c? + c? - cj) + g Ae (E: - E: + B: - Be) 0 L S + i Ayk (Ryk - Ryok - Ry-k + R¢+k - Ryk) ‘o S o S + . C. - C. - E g uJ C J J) + g “e (Be e) o S o L + E qu (RYk ' R‘Y'k) + E 11k (Rk' RYOk) where the A's represent shadow prices of restricted resources and the u's equal salvage prices when the respective constraints become effec- tive. Location of a saddle-point for the function will be necessary 63 and sufficient for maximization. Satisfaction of Kuhn-Tucker conditions is necessary and sufficient for location of a saddle-point. Kuhn-Tucker conditions are included here only for roadway elements . This procedure is proper when roadway adjustments have no significant implications for appropriate stocks of power and movement equipment. Since the concern of this research is with lightly traveled lines, abandonments are as- sumed not to affect optimal levels of rolling stock. For broader system adjustments the entire model must be employed to account for the inter— dependence of multiple durable inputs. Kuhn-Tucker conditions for roadway inputs require 5L = _ _ , 6L L L T ka AYk uk.<0,—L-—Rk 0,RYk>_0 6R k 0 5R k 0 0 YO Yo 6L _ S _ . 5L = 31?: - Pv-k Ark ”Yk < 0’ m RY'k 0’ RY'k >' 0 g V 0 6L _ _ . 6L = . 6 Y+k - AYk P¢+k ('0, 1wk RY+k 0’ RY+k The second condition for each roadway irput states an either-or condi- tion.. Either marginal gain equals marginal cost, describing an action situation and setting the partial derivation to zero, or marginal gain is less than marginal opportunity cost, resulting in zero use of the factor. x The third condition for each factor maintains non-negative quantities of all factors in the solution. 64 The first condition for each factor provides investment-disinvestment guidance criteria. Multipliers )‘yk are shadow prices of marginal units of roadway irputs of capacity y at station k. In other words, the Ayk denote the value of marginal roadway operations in the production pro- cess. As long as no more of a roadway element is sold than exists 11k, qu = 0. Summarizing the Kuhn-Tucker conditions, without excessive salvage activities, marginal revenue product may fall into one of four marginal factor cost intervals. Marginal revenue product is marginal revenue times marginal product. Where rail freight rates are fixed, as assumed here, not marginal re- venue equals rail service price adjusted for associated costs of opera- tion. Marginal product is the output generated by the marginal tmit of input. A marginal unit of roadway is a line segment leading to a revenue generating point, a station, in the direction of the line ter- minus. Thus, marginal product is total output from a marginal unit of roadway. Marginal revenue product is, then, the total net revenue accru- ing to the railroad firm from traffic originating or terminating on the marginal roadway segment . F If marginal revenue product of line k is equal to or greater than the marginal cost of building roadway capacity to station k, the line will be improved. The term P$+k represents an ordered array of costs of capacity acquisition opportunities. Secondly, if marginal revenue product is equal to or less than the marginal net gain of reducing road- way capacity to station k, auxiliary facilities will be sold or mainte— nance standards reduced. The term PE-k represents an ordered array of 65 values of capacity salvage opportunities . When marginal revenue product of roadway leading to station k is equal to or less than the associated liquidation value, P: k’ the line will be sold to another entrepreneur or dismantled. Only gne such best alternative exists, considering sales value and diversion of traffic. Finally, if marginal revenue product is less than capacity acquisition price and greater than capacity sal— vage value, roadway will be left in its current condition for continued operation.\) W The Bound of Market SLpp ly [The criteria for roadway investment and disinvestment reveal the boundary for voluntary market provision of railroad service. When the present value of expected net operating revenues, on a particular road- way segment, falls short of net income obtainable by liquidating the enterprise and investing resources elsewhere, market forces urge abandon- ment. This does not necessarily mean abandonment should be implemented. Measurements of net revenue and liquidation price reflect only finan- cially effective desires articulated in the market by suppliers of factors and purchasers of services . Where continued operation of lines holds positive associated values not expressed in the market communica- tion system, the boundary of social provision may be more broad than that of the market. \_ Development of these concepts will be deferred to Chapter V. The investment—disinvesment criteria previously constructed do provide guidance for public action. If one assumes that public agencies act as collective agents to articulate demands not effectively expressed in the market and that public action operates to encourage, rather than 66 force, continued socially desirable railroad service, then public action will be designed to neutralize market pressures urging abandonment. This assumes continued application of the Brooks-Scanlon doctrine of noncon- fiscatory public action, introduced in Chapter II. ,EIhe abandonment criterion, then, serves to measure the degree of public remtmeration necessary to make maintenance of a roadway segment the best opportunity for a railroad company.)1 This measure may serve to guide federal and state rail line subsidy programs established under the Regional Rail Reorganization Act of 1973. TThe function of decision criteria is to separate an entire decision space into clearly defined, mmtually exclusive regions . The abandonment criterion divides the space of all possible decisions into abandonment and nonabandonment alternatives . To prevent abandonment , discounted net revenue generated on marginal link k must be greater than or equal to liquidation value of the line, that is L ZpikYikipyk 1 0 where Pik is a set of discounted prices of rail service net of operating cost, to commodity i on link k, and yik is the amount of service ex- pected to be produced for commodity i on link k. The left-hand term is the current value of expected net revenue to be generated by the mar- ket. The right-hand term is the value of the highest liquidation al- ternative available to the railroad. The difference in these values represents the minimum present value of subsidy, U0, necessary to encourage voltmtary maintenance of roadway, that is i] \J 67 .. L _ Uo'Pyok Epikyik' When U0 is less than zero, that is, when revenues from operation are greater than income from the salvage alternative, no subsidy is required. The market will support the rail line enterprise and external net bene- fits will be enjoyed without collective charge. When U0 becomes positive, either a lutp sum subsidy of size Uo or an annual subsidy payment, Ua’ must be provided to encourage retention of the line, where U = MP1” 8 Y Ok ' E Pik yik)’ This subsidy estimate assumes an agreement of an indefinite term and discount rate ‘14. The annual subsidy computed in this way amounts to a public agency giving the railroad a bond of value Uo with an annual coupon with interest rate ‘1‘. Determining whether such a subsidy is warranted requires answer to the following question. IFMDO net benefits excluded from market accounting exceed the price of subsidy? Answer to this question requires defini- tion of the social bound to rail roadway provision which will be devel- Oped in Chapter V.: However, procedures for estimating the level of magnitude of required subsidy need not be postponed. ggerationaliziane Abandonment Criterion Application of roadway disinvestment criteria requires estimation of discounted net Operating revenue attributable to a marginal roadway link and salvage prices for each capacity reducing opportunity. Abandon- ment typically is activated only on roadway of lowest possible capacity with single track, low maintenance standards , and lacking traffic control systems. These lines generally lead to end points of operating divisions ' 68 making bridge traffic an insignificant contributor to branch revenues . DeSpite these common characteristics, railroad lines considered for abandonment are not homogeneous . Each has a unique set of cost and sal- vage price characteristics which require individual treatment in design- ing effective subsidies. The abandonment criterion, in operation, cannot be reduced to a simple formula with parameters defined. A procedure for using the criterion will be developed here. Also some estimates will be made to gain an understanding of the level of magnitude expected for various elements composing the criterion. Procedures for estimating roadway liquidation value will be addressed first, followed by dis- cuss ion of net revenue measurement. Recall that roadway liquidation value is composed of present values of several elements, net salvage value of materials and land, ad valorem tax savings, the portion of maintenance expenditures not associated with traffic and netlosses of joint facility rents, that is PLk sS+T+.43M-J. Yo The value of each component varies considerably between railroad com- panies and between rail lines. [Thirty-two Interstate Commerce Commis- sion questionnaires, required of railroads seeking line abandonments, were reviewed to obtain information on salvage values, normal mainte- nance costs, rehabilitation expenses required to continue Operations and net revenues for the last three years of Operation before application. All cases were applications to abandon roadway links in Michigan in the period 1968 through 1972. Magnitudes of some liquidation price compo- nents were obtained by making rough estimates from questionnaire data. 69 Three elements make this liquidation value identity unique for each roadway segment, value of land sales, joint facility rents, and reha- bilitation cost. Land values vary widely depending upon location. Of the thirty-two questionnaires Stpporting rail line abandonment applica- tions, fourteen identified the value of land sales as a distinct item. Within these fourteen cases land value per mile ranged from $18 in a sparsely populated portion of Michigan's .Upper Peninsula to $25,000 on a four and a half mile segment just beyond the limits of Detroit, Michigan. The mean value of land per mile for the fourteen cases was $3,949 while the median values for the even numbered sample were $414 and $419. Railroad land abandoned in cities is often highly valued com- mercial property. In undeveloped areas rights of way may have little value. Joint facility rents refer to income received by the roadway owner from other users of the line. These rents depend tpon contracts enter- ed into with other railroads under ICC supervision. Of the thirty-two abandonment cases studied, only two involved joint trackage rights. Rehabilitation expenses are accutmlated maintenance expenses neces- sary to rebuild neglected roadway. These expenses are avoidable through abandonment, but usually necessary for continued operation. The history of maintenance neglect, number of bridges, type of roadway base, and climate all affect the level of expense required to reconstruct roadway. Twenty-one of the thirty-two abandonment questionnaires observed re- ported estimated rehabilitation cost. Figures ranged from $11,669 to $77,586 per mile for reconstruction, with a mean of $23,805 per mile and median of $30,703 per mile. Rehabilitation cost estimates are frequently challenged by protestants in ICC abandonment hearings for representing 70 renewal to a standard far above that necessary for local service. Even if these estimates are high, rehabilitation may well require substantial amounts of resources . Ad valorem taxes do not represent an element of liquidation value which is unique to lines, but ad valorem taxes are not amenable to reli- able estimation, in Michigan. In 1905, Michigan became one of the first states to centralize prOperty tax collection for railroads.” The Michi- gan formula for valuation of railroad property is a complex assessment of total company net worth prorated to Michigan by a series of methods. Capitalized earnings are prorated by the proportion of system ton-miles produced in the state. Market values of engines and cars are prorated by prOportions of engine miles and car-miles operated in the state, re- spectively. Half of the total net worth apportioned to Michigan is sub- ject to a rate of taxation determined by the State Tax Commission and applied similarly to all railroads. The tax rate has grown steadily from 37.6 mills, in 1965, to 49.1 mills, in 1973. Consequently, pro- perty taxes cannot be apportioned to roadway segments in proportion to length. Indeed, the railroad tax unit of the Michigan Department of the Treasury has no means by which to estimate _a_d valorem taxes attribu— table to individual railroad links. Two liquidation price elements reported in ICC abandonment ques- tionnaires bear some regularity, net material salvage value and annual maintenance cost. These values, too, vary considerably between line Segments in a manner preventing precise estimates with a general fonmla. g Y N 20Michigan Public Act 1905, No. 282, as amended by Public Act 1953, o. ‘30. 71 However, estimators of these elements are fruitful for understanding the approximate value of resources occupied in rail roadway. Net material salvage value is the difference between gross salvage value and cost of dismantling roadway and structures. Results of test- ing regression estimators for data included in twenty-three abandonment questionnaires are reported in Table 6. The purpose of this exercise is to provide readily useful estimators to roughly calculate levels of magnitude of liquidation price elements . Results of the simple estimators show that most of the variation in gross salvage value and removal cost can be explained by length of the line segment and location. The first three equations reveal a nearly linear relationship between gross salvage value and length of line. Equation 5 shows that removal cost increases at a declining rate as length of line increases. The net result suggests some economy in re- moving longer roadway segments. Gross material salvage value does not vary significantly between locations, though cost of removal is signifi- cantly less in the UpperPeninsula. Estimators one and four of Table 6 will be used to calculate gross material salvage value and removal cost, respectively. These estimators bear the lowest standard errors, thereby providing the most reliable predictions. If the market value for materials and the cost of removal are independent of one another, expected net material salvage values can be estimated as the differences in predicted gross salvage value and removal cost. Net material salvage value estimates for segments of mean length are shown in Table 7. These estimates must be used care- fully since standard errors of estimates are quite high. Where gross salvage value and removal cost are independent, standard error of net 72 .335 8.3 ma 8me ooufilfieozu 05 how 533 532 mNN.a~m.H~V 5H4.awmv o~.mma.m4 NNm.o oa.amm.~4- «gmm.mfia.4 “moo Hmsosum .o flea.ema.oav hwo.wflv Ame.flamv om.amm.~m oam.o «¢om.mmm.om- «gmo.ma- «wem.moa.m pmou Ha>osmm .m “No.HeH.mav neH.HV Amm.awc Amm.mao.flv 4N.oem.om «Nm.o «a~m.¢m~.am- mH.~- Hm.mm «eme.eom.m “moo He>osam .e . floa.oo~.mev noe.oma.av Q=He> am.woo aw mom.o wa.m~m.am- «gow.mea.m mmeseam macaw .m fiaa.aea.mev “4N.mev Asa.mam.mv osaa> Hm.oom.mm New.o Ho.owe.m~- 4H.em *«co.N4m.a mma>amm macho .N AaN.Noa.H4U had.mv Acm.me~v nNa.Hmm.4V ma~m> Na.m~m.mw omw.o mw.wwa.o~- om. - “a.mme Ha.eme.fl mmm>~mm macho .H ougumm . «3...:an «Seas, wmmwmwhwm mm gone: m T3983 N 93 weed 5984 unopcomon Nama-woaa .mmeae Home eawaeufiz pom ecumeeoe meoapauafiaa< oceanoeeme< oopfiubeog now umou H9659“ pew 33> ommzmm 333m: $95 no.“ wepmfimumm .o 033. 73 material salvage value is $90,762 for the mean length roadway segment, or $5,139 per mile. Table 7. Estimates of Net Material Salvage Value for the Mean Length of TWenty-Three Line Segments Under Abandonment Application, 1968-1972 I Lower Peninsula , Upper Peninsula term Total 4 Per Mile Total Per Mile Gross Material $137,226 $7,770 $110,437 $6,254 Salvage Value , Removal Cost $113,028 $6,400 $ 61,794 $3,499 Net Material 8 24,198 $1,370 $ 48,643 $2,754 Salvage Value Mean Length is 17.66 miles. Normal annual maintenance cost for roadway can also be estimated roughly. Normal annual maintenance cost is that expense incurred in , keeping a line at a constant? repair standard, after being rehabilitated to the standard. An estimate of this value was provided in twenty of the ICC questionnaires attached to abandonment dockets. Estimators are constructed similar to those for salvage value; results are reported in Table 8. Most of the variation in maintenance cost can be explained by length of line. Line location appears to be an unimportant determinant of maintenance cost, within the state. Equation one of Table 8 will provide a rough estimator of mainte- nance cost. At mean length of 13.75 miles, annual maintenance cost is approximately 41,409.82 or 3,012 per mile, in the Lower Peninsula. This level of magnitude appears reasOnable compared to average running track maintenance expenditures for the entire systems of the Norfolk and 74 dead: mnfifi 3 598a new: naa.aHH.Nc flao.amv amoo ma.mm4.~ aom.o wa.oem.a- «amw.oaa aueaeaaaaaz. .m noo.aH4.Hv fimH.~v flea.aae pace am.mam.a aaa.o Hm.H~ ¢4HO.HH- «aom.a~a aueaeaaaaezn .N moa.mam.av fiaN.oU nao.mav fima.HmHV aaoo Eds; nae enema «$5 tag? geese 68885§ A ougpmm m Haaaaaaa ‘ ,uaaaaaa> wmawmaawm Na 8%: m flfiwaad N flfimeflv £33 “Bataan A Naaa-maaa .eaaaaoaaaa< aeaseoeeaa<.aaea: maaae flame eamaeuaz fine; now umou 8535.32 33524 H8502 mo mougpmm .m mama. 75 Western Railroad and the Chesapeake and Ohio Railroad, two financially healthy companies operating in Michigan. Total annual maintenance accounts for running track were divided by both length of road and by total mileage of running track; the latter figure includes multiple tracks and sidings which require less maintenance per unit. These two figures are quite similar for the two example companies. The Norfolk and Western Railroad and the Chesapeake and Ohio Railroad spent$4,249 and $4,254, respectively, per mile of roadway for maintenance of running track. Equivalently, the two railroads Spent $3,115 and $3,076, respectively, per mile of all ruming track. One may expect roadway maintenance cost per mile on lightly traveled branch lines to more closely resemble second tracks than mainlines . Investigation of thirty-two abandonment applications has revealed the uniqueness of each case. While estimators of same liquidation price elements provide general understanding of avoidable opportunity costs, calculation of effective incentives require line—specific investigations . Agencies designing line continuation incentives would find it wise to train rail line appraisers to calculate the value of liquidation price elements . Liquidation price is compared to the present value of expected net future earnings attributable to a railroad link, which would be lost by abandonment. Annual net earnings is the difference between operat- ing revenues and operating costs obtained by accounting procedures of the ICC. Relevant operating income includes the entire amount of revenue attributable to shipments originating and terminating on the branch line. This value is composed of on-line charges for origination and termination services and that part of total freight revenue apportioned 76 to the owning company for line haul operations on off-branch lines. The revenue figure must be adjusted downward for any amount of income which will be retained for traffic diverted to other portions of the company's lines. To the degree that traffic is diverted to company lines, revenue losses are reduced, increasing the amount of incentive payment required to encourage maintenance of a roadway. Relevant operating costs are calculated similarly. All costs to the company incurred by handling traffic to and from the line under study are to be included. Operating costs represent long run marginal costs. Costs associated with branch Operations and costs incurred in off-branch line-haul operations are included. ICC accounting procedures suggest calculating off-branch operating expenses at one-half the value of off-branch operating revenues. Costs of handling traffic diverted to other portions of the company's lines are to be subtracted as un- avoidable with the proposed abandonment. The value of subsidy necessary to relieve market pressures has . been calculated for twenty-one of the thirty-two abandonment cases selected. Estimates are based Lpon data provided in the questionnaires submitted by applicant railroads. Application of the salvage and main- tenance cost estimators is not appropriate since these same cases serv- ed as the sample used to construct the estimators. Total operating revenue attributable to a line less attributable Operating costs, in- cluding g valorem taxes, was compared to the sum of net salvage value, the portion of normal annual maintenance expenditure not related to traffic, expected rehabilitation eXpenses and joint rent losses. All values were converted to present values assuming an indefinite time 77 horizon and an eight percent discount rate, the 1972 average railroad bond rate. The results appear in Table 9. The range of annual subsidy per mile required to cover Opportunity losses of maintaining roadway range from $905 to $7,107 with a median of $4,631. Calculations for the Chesapeake and Ohio Railroad under- estimate subsidies required to continue operations by an amount equal to the salvage value of land. Present value of net Operating revenue was negative in twelve of the twenty-one cases. Operating deficits had to be added to liquida- tion prices. This signifies that railroads tend to seek abandonment not when Opportunity losses begin to occur but when accounting losses appear. By the time railroads reach Operating deficits, substantial economic losses are incurred.’ Whether railroads create such financial pictures by discouraging traffic or whether these conditions are the result of reduced demand is not a key issue. This argument has been allowed to cover the deeper issue for some time and has created a great deal of animosity between railroads, shippers, and.public agencies. That railroads either feel compelled to display Operating deficits or that railroads continue Operations until Operating deficits occur, reveals a tendency to overinvest in:roadway for periods extending beyond finan- cial health of individual lines. Exclusion of Opportunity losses and high uncertainty surrounding abandonment approval may be reasons fer not fine-tuning investments to maximize market Opportunity. The Power of Pricing Poligy Previous development of roadway investment-disinvestment criteria assumed no limitations on.management detenminations except fOr pricing policy. Prices were assumed exogenously fixed implying either perfectly TABLE 9. Rail Segments Under Abandonment Application, 1968-1972 78 Estimated Annual Subsidies Necessary to Maintain Twenty-One Total Annual 6...... $9.?) 5.3.... "952’ 5.3.... "111113“ 0 a C & O 19.00 158,376. 11,313. 12,670. 905. c 8 o 9.00 519.955“ 57.773“ 91.596“ 9,622“ c & 0 29.69 1,975,992“ 59,902“ 118,079“ 9,792“ c a 0 12.96 737.061“ 59.159“ 58,965“ 9,732“ 0 & 0 7.13 358,622“ 50,298“ 28,690“ 9,029“ c a 0 2.97 191,095“ 77,396“ 15,289“ 6,188“ c 1 0 15.03 737.099“ 99,092“ 58,068“ 3.923* c & 0 7.29 152,339“ 21,091“ 12,187“ 1,683“ c & 0 0.97 91,759“ 88,838“ 3,390“ 7,107“ C & 0 8.82 287,592. 32,607. 23,007. 2,608. c & 0 11.69 279,616“ 23.592 21.969“ 1,887“ PC 9.3 308,060 71,692 29,695 5.731 PC 37.95 2,168,101 57,893 173,998 9,631 Pc 5.9 291.993 99.990 23.359 3.959 PC 2.9 181,282 62,511 19,503 5,001 PC 19.8 785,877 39,691 62,870 3,175 PC 201.9 12,786,653 63,332 1,022,932 5,056 PC 25.5 1,038,189 “0,713 83,055 3,257 01w 35.57 2,959,806 83,070 236,389 6,696 C & NW 35.1 2,800,696 79,792 229,056 6,383 $00 30.5“ 1,388,612 95,969 111,089 3,637 *Excluding land sale value. 79 elastic derived demand for railroad transport orcontinued regulatory influence over the pricing function. Consequently, magnitude of branch line losses has been determined conditional upon a set of fixed prices corresponding to a set of multiple products. Relaxing the assunption of predetermined prices will allow market conditions to influence pric- ing policies designed to reach management objectives. This will com- plete the view of the market bound to railroad service supply. Firm pricing policy is a statement of principles by which prices of offered goods and services will be determined. Firms seeking to maximize net revenue over time tend to establish an output level at which long run marginal cost equals demand price. Implementing Clemens' notion of firms as sellers of capacity rather than sellers of products, one may say profit maximizing firms tend to equate long run incremental cost associated with a last unit of capacity with the demand price of items emected to be produced by that capacity. Two characteristics of railroad Operations have caused other than marginal cost pricing policy to be considered. First, railroads pre- sunably exhibit decreasing unit cost in production throughout the rele- vant output or capacity range, owing to the high proportion of non-variable costs relative to variable costs, over long periods. The truth of this notion was questioned earlier in this chapter. Continually decreasing long run average costs imply smaller long run marginal costs at any selected output or capacity level. Consequently, if the demand facing the firm exhibits an inverse relationship between price and quantity demanded, pricing at marginal cost will not generate revenue sufficient to cover total costs over time. In this instance marginal cost pricing generates a deficit. One alternative is to adopt a policy of marginal 80 cost pricing and seek government subsidies to clear the deficit. This approach is beyond the market bound. A market alternative is adoption of an average cost pricing policy with which the firm would establish prices equal to unit cost of operating and amortizing company facilities, including normal profits. In comparison with marginal cost pricing, average cost pricing generates higher prices and discourages demand. However, average cost pricing allows the firm to cover its total costs and remain in business. This pricing policy is often attacked on the grounds that as long as demand, representing marginal value to consuners of additional units of output, lies above marginal cost, general welfare could be enhanced by applying sufficient additional resources in produc- tion to increase output. This argument is used to justify the public subsidy alternative. Secondly, railroads are producers of a nunber of distinct products sold in distinct markets. Under certain conditions a firm serving ”sev- eral markets can discriminate in price between markets. Price discrimi- nation is typically defined as the differential pricing of different units of a single product, where the price differences bear no direct relationship to cost of production. The central objective of discrimin- atory pricing policy is to capture a larger proportion of the demand price particular groups of consuners are willing and able to pay. The necessary conditions for workable price discrimination may be met in railroad service markets. First, markets are clearly separable by com- modity and origin-destination. Secondly, railroad services are perfect- ly perishable and so specifically defined by conmodity and location as to preclude arbitrage activity. The final necessary condition requires that the selling firm have some control over price in the markets served. 81 Railroads do not always enjoy such influence over price, but in some circunstances a degree of price control may be possible. This condition must be explicitly assessed in each situation. Existence Of more than a single railroad in a community and relative abilities of transport production between modes determines a railroad firm's discretion with price. One advantage Of discriminatory pricing policy is the ability to generate an average revenue covering costs where a single price would never justify production. Imagine demand relationships for two separ- able markets which both lie wholly _below average cost. NO single price could justify long term production. However, with high prices in the market Of more inelastic demand and lower prices in the market Of more elastic danand, the potential exists for an average price on total out- put which exceeds average cost. Under this special Circunstance, dis— criminatory pricing policy allows the firm to Operate profitably at a positive level Of output. Discriminatory pricing policy may also be applied tO multiple pro- duct firms. Pigou described three degrees Of price discrimination.“ The first and second degrees, perfect discrimination and discrimination in price between discrete output blocks, respectively, assune single product production and a single demand curve representing the various classes Of clientele. Third degree discrimination presunes the division Of customers into groups , each group having a unique continuous demand function . 21F. M. Scherer, Industrial Market Structure and Economic Perfor- mance (Chicago: Rand MENaIIy E Company, 1970) , pp. 2‘53-254. 82 Multiple product price discrimination is an extension Of Pigou's third degree. Clemens redefines discrimination for multiple product firms. Price discrimination exists in essence wherever a firm, pro- ducing a series Of products, however differentiated, under joint cost conditions, recovers varying ratios Of such costs by charging what the traffic will bear for each product.22 ‘ In effect, Clemens adds a fourth necessary condition that products be created with comnon or joint costs Of production. Railroads as multiple product producers fulfill this requirement. As durable assets are shar- ed by product lines, either simultaneously or in successive periods, a firm incurs joint or comnon charges. Though these costs must be cov- ered tO maintain production, these costs carmot be allocated directly tO particular product units. Nonallocable costs of durable resources may be recovered from any unit of sales, not necessarily in proportion to the contribution Of the resource. This situation encourages firms tO sell at higher prices in markets least sensitive to price and at lower prices in markets more sensitive to price. In the bargaining between shipper and carrier the joint item (supplementary expense) will fall more largely upon the shipper who is more anxious tO ship, and he will be the one for whose comodity there is a more intense demand.23 There are two rules for pricing policy when multiple outputs are produced with transferable, durable resources and market demand relation- ships are independent. First, to maximize profits marginal revenue must 22Eli W. Clemens, "Price Discrimination in Decreasing Cost Indus- tries," American Economic Review, 32 (December, 1941), 794-802. 23Haney, "Joint Costs," pp. 235-236. 83 be equal in each market and equal tO marginal cost Of the last unit Of output.“ Secondly, a firm will enter markets with successively greater price elasticity Of demand until demand price equals marginal cost. A profit maximizing firm producing one product would select an output level equating marginal cost and marginal revenue. When the firm perceives an Opportunity to shift durable resources to produce for a second market with greater price elasticity Of demand, production for the two markets will be balanced tO equate marginal revenue in each. Output for the originally produced good is reduced and the price raised. This process continues until the demand price Of the last market entered equals the marginal cost Of production. Beyond this output level marginal cost lies above marginal revenue , not warranting production. . 2“A profit maximizing firm producing n products will maximize I: p ixi - C(X) where pi and xi are price and output Of product i, 1 H i = 1, ..., n, and C00 is the total cost function. Maximization re- quires setting first order conditions tO zero 6H _ _ = 3'32]: " piU- + l/ni) (3'00 0 or 1310 + l/ni) = pj (1 + l/nj) = 000 i #1 3 that is marginal revenue from each product is equal to that Of every other product and tO marginal cost. Second order conditions require 6p-(1+1/n-) 6X 1 i that is, marginal cost must cut marginal revenue from below. 84 The three pricing policies discussed, marginal cost, average cost, and discriminatory pricing, by no means exhaust the multitude Of possibilities. These three alternatives do represent those most Often discussed in dealing with railroad and utility rate structures. In principle, marginal cost pricing is preferred among economists to make the most efficient use Of society's resources, given the interpersonal structure of utilities and distribution Of income which together deter-— mine effective demand and derived demand for transport services. How- ever, Vickrey represents the context which limits application Of this pure principle. As a preface to a discussion Of the role Of marginal cost pricing, it is perhaps well to state explicitly that in common with any other theoretical principle the principle Of marginal cost pricing is not in practice to be followed absolutely and at all events, but is a principle that is tO be followed insofar as this is compatible with other desirable Objectives, and from which deviations Of greater or lesser magnitude are to be desired when conflicting Obj ectives are considered.25 Imperfections noted by Vickrey include the time and cost involved in determination and publication Of rates as well as the time and costs to consumers Of services tO intelligently respond tO price changes. These factors preclude rapid gyrations in prices required for strict implemen— tation Of short er marginal cost pricing. Also Vickrey notes that where strict long mm marginal cost pricing spells financial disaster for decreasing average cost firms, the need for revenue calls for al— ternative pricing policies. 25William Vickrey, "Some Implications Of Marginal Cost Pricing for Public Utilities," in Trans ort, ed. by Denys Mmby (Baltimore: Penguin Books, Inc., 1968), p. 98. 85 Of the remaining two policies discussed, differential pricing ap- pears tO have the most support in the literature. Average cost pricing is viewed as a poor substitute for marginal cost pricing when designed to generate revenues to cover costs Of production, for the policy fosters inefficient use Of society's resources. Differential pricing, on the other hand, is viewed as a complement tO marginal cost pricing which has . the ability to generate greater revenues than will marginal cost prices and stimulate efficient investment and output levels. Bamnol notes the conplementary relationship Of marginal cost and differential pricing policies The margin above incremental costs which maximizes [the contri- bution tO overhead burden and thus to net income] depends Upon the price sensitivity Of demand, determined "primarily by the alternatives available to shippers . . . .,Thus while incre- mental costs should not determine prices or rates, they set the lower boundary within which pricing decisions should be made.2 Differential pricing has been suggested both as a means tO make production possible in decreasing cost firms and to stimulate efficient allocation Of resources. While the former may be possible under certain conditions Of derived demand, the efficiency characteristics Of differ- ential pricing must be examined very closely. Baunol says "differential pricing is consistent with the public interest in the economical utiliza- tion Of resources.",27 Clemens concludes that multiple product price discrimination serves as a substitute for public subsidy Of decreasing 26William J. Baunol, et al., "The Role Of Cost in the Minimum Pric- ing Of Railroad Services," 1n'Trans ort, ed. by Denys Munby (Baltimore: Penguin Books, Inc. , 1968), p. 121. ”mm. , p. 125. 86 cost firms.28 ZMultiple product firms continue tO invade new markets until marginal cost equals demand.price, implying a socially optimal level Of output. Clemens uses a geometric application Of Pigou's second degree price discrimination tO establish his thesis. Second degree discrimination requires a single continuous demand relationship with distinguishable blocks Of output. Discrimination essentially always results in greater Outputs, under these circunstances, than with a single product price. HOwever, second degree discrimination does not represent.multiple product production.. Third degree and multiple product price discrimination, which best represent railroad markets, are less certain in their implications for socially optimal output levels. In these situations while output in the marginal market increases, outputs in intraemarginal markets are reduced. Whether total output with.multiple product price discrimina- tion is greater, equal to, or less than total output with a single price policy is not readily apparent. Joan Robinson has provided conditions under which total output may increase, decrease, or remain unchanged by moving from a single monopoly price to third degree price discrimination.29 .As new market opportuni- ties arise, firms tend to enter or increase production for markets Of greater elasticity and lower price. Simultaneously output will be re— duced in the less elastic markets and prices raised. Assuning demand curves are convex to the origin, total output then will decrease, re- main the same, or increase according as the more elastic demand curve is 28Clemens, "Decreasing Cost Industries," p. 800. 29Joan Robinson, The Economics Of Imperfect Competition (London: MacMillan 8. CO., Ltd., 1933), pp. 188-193. 87 Of lesser, equal, or greater degree Of convexity than that of the less elastic demand relationship. The case Of two straight line demand curves is a special case of equal degrees Of convexity for which differential product pricing implies no change in total firm output relative to a single price policy. Consequently, one cannot judge §;pgiggi_whether differential pricing will stimulate a more optimum.level Of output than charging all consumers alike. Scherer provides another argument that multiple product price dis- crimination does not necessarily lead firms to produce at levels Of socially Optimal output.30 Scherer points tO the fact that marginal cost equals demand.price only in the last market served; in all other markets demand.price lies above marginal cost. Consumers are willing to pay more than marginal cost for additional units of product which are not being produced. While resources may be used efficiently in.produc4 tion Of outputs for the last market, insufficient resources are devoted tO products for the markets Of less elastic demand, in the efficiency sense. Nhs. Robinson does conclude, however, that in cases where price discrimination is necessary tO make production feasible, such discrimina- tion does promote efficiency Of resource use. It is clearly desirable that price discrimination should be permitted in such cases, for the average revenue Of the mono- polist cannot be greater than average utility to the consumers. If average revenue is greater than average cost, average utili- ty will also be greater, and the investment will lead tO a gain to society.31 30Scherer,.Market Structure, pp. 260-261. 31Robinson, Imperfect Competition, pp. 203-204. 88 Stigler rebuts this argument, in part, saying that discrimination does "not necessarily" provide gain to each consumer when required for out- put. His argument faults Mrs. Robinson's statement for being tOO par- ticular in view, ignoring price effects on other industries. . . The production Of one commodity that is priced discrim- inatingly will Often affect the prices Of other commodities. If a railroad will haul coal for 1 cent per ton—mile and dia- monds for $100 per ton-mile, the shipper of diamonds may be compelled tO use the railroad because it has driven out Of existence the former stagecoach industry that hauled both commodities for 5 cents per ton-mile.32 The substitution effects implied by low prices Of railroad service in markets Of price elastic demand have implications for long-run develop- ment Of a full range Of transportation facilities in an area. Substitu- tion effects on railroad competitors may be particularly critical in areas which generate a marginal amount Of total exchange with other re- gions. The issue Of effects Of price discrimination on related industries may be treated in similar fashion to the problem Of using consuners' surplus as a measurement technique. Price discrimination amounts tO the capture by firms Of some Of the consumers' surplus evident under single price policies. Consuners' surplus can be validly used as a rough measurement tOOl only if interactions with all related markets can be monitored. This requires railroad service to have only a few, identi- fiable substitutes or complements. Conceptually, then, one can trace the impacts Of price changes in one market on the prices and output levels Of related markets. The technique described is similar tO Bailey's model Of output and price determination for various products Of multiple 3"-George Stigler, The Theory Of Price (New York: The MacMillan CO., 1952), pp. 218-219. 89 product firms.33 Here two distinct markets are considered, one for railroad services and the other for a railroad substitute. Figure 1A represents the market for railroad services. Multiple demand curves are drawn conditional on different amounts Of sales of the substitute good. Demand curves are successively lower as more units Of the substitute product are produced and sold in the combined market, noted by the ascending order Of nunbers, noting related market outputs, corresponding tO successively lower demand curves . Marginal revenue curves associated with each demand curve are drawn and marginal cost Of production is as- suned constant for simplicity. Figure 1B is drawn similarly for the market Of products produced by the related industry. Demand curves in this market are successively lower for greater sales Of railroad services. Figure 1C represents a combined market for competing products. Demand for railroad services for different fixed levels Of competing products is represented by demand function X201. Demand for competing services for different fixed levels Of railroad services is represented by xl.2' Where these two curves intersect a simultaneous equilibrium exists in the twO competing markets. Returning to Figures 1A and 1B, one can determine equilibrium quantities and prices for each product. Let the price Of a particular railroad product decline leading to an increase in equilibrium quantity in that specific market. As output increases and is consumed, the market demand for the competing product is diminished. This is noted as a shift downward in the demand relation- ship Of the competing industry, corresponding to higher railroad service 33Martin J. Bailey, "Price and Output Determination by a Firm Sell- ing Related Products," American Economic Review, 44 (March, 1954), 82-9 93. 90 O ‘ . (mummy 1 ' (outlaw mum Figure l . sales. The carpeting industry of Figure 1B would equate marginal cost to marginal revenue at a lower level Of output. If continued railroad capture Of the transport market by means Of price discrimination was to push the relevant demand curve for the carpeting industry below average cost, the competing industry may be forced out Of business. Most assur- edly if the demand curve Of the competing industry was driven below aver- age variable cost, the business would fail, illustrating Stigler's example. Finally, price discrimination redistributes income. The purpose of price discrimination is to draw enhanced income away from shippers toward the railroad in order tO make a branch line a viable Operation. However, there is also a redistribution Of income between shippers , 91 relative to the instance Of single monopoly price or single competitive price. Those shippers with inelastic derived demands fOr railroad trans- port will bear the largest portion Of jOint costs while those with.more elastic demand will pay a relatively small share. In summary, multiple product price discrimination.may provide a market alternative tO public subsidy tO provide a condition Of profita- bility which will encourage retention Of rail lines. The characteristics Of resource efficiency and distributional equity associated with this policy are unclear. The strength Of this market mechanism depends upon answers to three basic questions in addition to fairness of distribution effects. First, does the railroad company have sufficient control over price Of transport to discriminate in pricing? Two necessary conditions must be fulfilled to answer this question.positively. One is that a margin must exist between current railroad rates and rates Of next best alternative transport, a margin within.which rail rates might vary with- out encouraging shippers tO select another mode. Where the higher priced mode has superior service quality characteristics, the price margin.must be discounted for the quality differential. The second necessary con- dition is that higher railroad rates not push shipping firms out of business, regardless Of next best transport cost. This requires Observa- tion Of the competitive environment Of shipping firms, that is, assess- ing the shape Of derived demand for transportation. The second question tO be answered about price discrimination is whether or not discrimination.would generate sufficient added revenues tO cover current losses, that is, is price discrimination sufficient tO maintain Operations. The answer to this question requires measurement 92 Of shipment volumes tines price changes tO arrive at a magnitude Of potential revenue change . A third question to be answered is whether price discrimination stifles transportation conpetitors or inhibits longer run resource ad- justment Of either transportation or rail user firms. Raising prices for transport tO some firms without justification in cost and lowering prices to others may create perverse incentives tending tO enhance use Of resources in inefficient activities and stifle use Of resources in more efficient enterprises. The first two questions must be answered by firms forming price policy. The third involves systemic dynamics Of external effects Of firm decisions. A rudimentary procedure to test the potential Of dis- criminatory pricing policy on branch lines makes use of actual freight rates Of railroad and alternative modal services. Ability tO influence prices requires that there exist a margin between the railroad rate and the rate Of the next least costly alternative. Alternatives consid- ered in Chapter VI are motor carrier, trailer-on-flat car (TOFC) , and shipment to and from a nearby railhead with truck assembly and distri- bution. The margin may be discounted or inflated by a percentage to ac- count for convenience and other service related values . Personal inter- views with individual shippers and receivers may reveal the canpetitive environment controlling the ability Of railroad users to accept higher freight rates. Some firms may not be able to stand increases in price to cover branch line deficits. Finally, an annual stream of revenue enhancement potentially to be gained by discriminatory pricing may be calculated by sunning the possible contributions Of railroad using firms on the subject line. The discomted net present value Of discriminatory 93 gains over the investment horizon may be added to the present value Of net revenue from Operations , resulting in a potential market value for the line. Potential market value may then be conpared to line liquida- tion value to determine whether continued operation lies within the broadened market bound. This procedure will be applied to railroad lines in a two-county region Of Michigan to test the power Of pricing policy in expanding the market bound Of supply. The measure Of potential revenue enhancement has application beyond price discrimination. This measure Of willingness and ability to pay above current prices also serves to measure the magnitude Of potential subsidy Offered in private collective action by railroad users. This magnitude will be diminished in proportion to the degree Of inperfection in product markets Of railroad users, allowing passage Of a portion Of ‘ increased freight costs on tO consumers. TO the degree increased freight charges are passed on, consuners themselves would be willing tO Offer subsidy for line retention if suitable mechanisms exist to consulmate the transaction. The present value Of sunned freight cost increases im- plied by railroad abandonment, becomes a conponent Of potential market value of the line whether incidence of added freight charges is upon railroad users or consuners Of their products. Sunmay Railroads have been described as multiple product firms where in- dividual products are distinguished by comnodity and location character- istics. The multiple product nature Of railroad firms complicates long term capital adjustment behavior Of managements. A competition is es- tablished between products, within firms, for use Of scarce, durable 94 resources. Where variable factors or market denand become constraining, excess capacity Of durable inputs is not inconsistent with optimal re- source use. Assuming branch lines to be abandoned are of mian capacity and that the Optinal amount Of movement equipment is not affected by a sin- gle branch line closure, a disinvestment rule was developed. Where dis- counted net present value Of future Operating revenues does not exceed liquidation value Of the line, continued Operation is possible only at a deficit equal tO the difference. Due tO the unique nature Of each roadway segment, liquidation value, and magnitude Of branch enterprise deficit, must be evaluated individually for each line. I Branch line deficits evaluated for twenty-one roadway .,segments under abandonment application revealed both the magnitude and the nature Of deficits. Deficits ranged from $905 tO $7,107 per mile suggesting con- siderable variation between lines. Branch line deficit evaluation also revealed that railroads tend to enter abandonnent proceedings when Oper- ating losses can be reported, at which time economic losses may be substantial. Two market mechanisms may exist through which added branch line revenue may be generated. Under certain market conditions, on-branch rate discrimination and collective user subsidies may potentially en- hance line revenues tO justify continued Operation. The Lpper limit tO this alternative is the value Of the difference between costs Of rail- road and the next least costly shipping alternative. This entire chapter has concentrated upon determinants Of the mar- ket bound Of railroad service supply. The concept Of marginal revenue product, to which marginal Opportunity factor costs are compared, has 95 been assumed. .As important tO the investment decision as cost of pro- duction, is the likely level Of future demand on a particular line seg- ment. The next chapter considers the nature and determinants Of pro- spective railroad service demand. I CHAPTER IV THE MARKET BOUND -- DEMAND Application Of theory and empirical measurement Of demand for transportation services has lagged far behind treatment Of production and cost relationships. Not until the decade Of the 1960's did a sig- nificant volune Of this work appear. Some rather novel concepts have been developed to eXpand the theory Of derived demand. Ernpirical work with freight transportation demand is new enough that the chief value Of this activity has been development Of a stock Of statistical experi- ence rather than a “stock Of valid estimates Of relationship parameters. The results Of treating railroad service demand here also must be viewed only as one more step in developing experience with transportation demand estimation. A review Of previous approaches will precede construction of derived demand models used in this investigation. Both quality re- sponse and modal split models are developed for use in a traffic fore- casting technique. Since survey data is spent designing estimators, parameters based upon the same available data are unreliable for traffic forecasting in this project. Valid parameter estimation requires data samples independent Of the sanples used in estimator development. ' Two types Of denand investigation predominate. One type emphasizes a particularist approach to identificationand measuranent Of various determinants Of demand, for each mode. Products Of transportation have typically been recognized as possessing nunerous characteristics other 96 97 than price which affect demand. Multiple regression analysis has been the most common method for distinguishing the relative influence Of each determinant. The second type Of investigation views the entire trans- portation planning process with broader scope. Techniques Of traffic forecasting dominate this field. Meyer, 53 a1. , was one Of the earliest to approach freight trans- port demand as a means to determine the feasible revenue gain with value- Of-service pricing as opposed to marginal cost pricing.1 Ability to charge prices above marginal cost is inversely related to elasticity Of derived transport demand which, in turn, varies directly with elas- ticity Of demand for the product being shipped and with theiproportion Of total commodity value composed Of transport cost. Many bulky, low- value-per-unit commodities such as gravel and sand have price responsive markets and total value Of materials is largely composed Of transport costs. These products tend to have elastic transport demands. Trans- port costs used by Meyer, _e_’_c_ a1. , include costs Of storage and interest associated with transit time and minimum shipment volumes. The earliest major attempt to empirically measure price elastici- ties Of freight transportation demand was performed by Perle.2 Short run own and cross price elasticities Of demand for railroad and motor carrier services were measured with five years Of annual time-series data. Perle recognizes the potential influence Of non-price 1John R. Meyer, ‘et a1. , The Economics Of Competition in the Trans- portation Industries (Carib-ridge: Harvard University Press, 1960), pp. 168-202. 2Eugene D. Perle, The Demand for Transportation: Re ional and Commodity Studies in the finite? States (Chicago: The Ufiiversity Of Chicago Fess, 1964]. 98 characteristics Of movement and service, but only as longer term.deter- minants of "secular change associated with intermodal competition and the fluctuations Of market shares."3 Measurement was made using a re- gression model with tons shipped as the dependent variable and rail and truck rates and regional and commodity group binary variables as inde- ' pendent variables. Poor statistical results led Perle to conclude that price behavior provides neither the sufficient nor the major answer to intercarrier competition. Perle Offered two alternative explanations. Either nonrprice effects are active in the short run or transport de- mands are regionally unique. The latter explanation was selected and nonrprice effects neglected. Subsequent contributions tend tO suggest Perle was premature in placing non:price characteristics Of transportation in an Obscure role. Craig has developed a behavioral approach to modal selection using price and quality Of service characteristics jointly.'+ Managers measure attributes Of each mode by levels Of anxiety and select the mode which best meets the Objective Of minimizing anxiety. Each modal character- istic is perceived differently under different environmental conditions and each.manager applies anxiety weights according to his own.predis- position toward each.mode. In Australia, KOlsen has developed a managerial utility model for modal choice similarly involving price-quality combinations.s Quality 31bid. , pp. 18-19. 1+Thomas'Craig, "A Behavioral Model Of Medal Selection," Traggporta- tion Journal 12 (Spring, 1973), 24-28. 5H.IML KOlsen, The Economics and Control Of Road-Rail Competition (Sydney: Sydney university Press, 1968), pp. 54571} 99 Of transport service is added at a cost and users are willing to pay higher prices for higher service quality. Assuming carrier and shipper firms maximize profits, carriers seek to Obtain the highest possible price above marginal cost and shippers seek tO pay the lowest possible price. The highest possible price one mode can receive for a particu- lar level Of a quality attribute is limited by the cost tO anothermode for providing the same service quality. Where modal competition exists,- the lower bourd Of price is established at marginal 'cost Of the highest cost producer. A very useful notion developed by this quasi-utility approach to derived demand is the implicit valuation by shippers Of an array Of service quality alternatives whether valuation is directly measurable or not. I The quality characteristics Of transport services are usually not taken sufficiently into consideration. Perhaps the main reason for this is the difficulty Of giving them their correct "value," whereas costs and prices are more easily ascertained. . . . The user . . . has little difficulty in determining which combination Of cost and quality is best for him.6 Though the ease, Of choice may be Overstated, the notion Of implied value weights, used by both KOlsen and Craig, suggests a revealed preference approach to transportation demand, even where dollar costs of consuming transport services are not readily identifiable. Numerous studies Of modal selection were undertaken in Europe dur- ing the latter half of the 1960's. Bayliss has summarized these inves- tigations by four general approaéhes . 7 The market research approach 5Ibid., p. 69. 7B. T. Bayliss, Demand for Freight Transport-Practical Results Of Studies on Market Operation (Paris: European Conference Of Ministers Of Transport, 1973). 100 amourts to asking shippers Of particular commodity types to rank a pre- selected list Of factors affecting modal choice. NO quantitative esti- mates Of characteristic elasticities are attempted. Results Of twelve such studies in different economic sectors and in different countries revealed that certainty Of delivery time, speed, tranSport charges, and safety were consistently leading influences on modal selection. Similar studies seeking the major factors influencing major changes in modal split show that slowness and delays, loss and damage, and increased charges are the leading causes of shift from railroad to motor carriage. Relative freight charges alone appear tO drive shippers to substitute rail for motor transport. Bayliss concludes that while market research reveals which quality characteristics are perceived to have value, the approach lacks ability tO compare relative intensities Of influence.8 Consequently, one may hear shippers complain Of service quality attri- butes while relative capabilities Of alternative modes to satisfy ship- per desires are insufficient to cause a change-in shippingpatterns. A second approach is a forecasting technique to project traffic flows ‘from broad-based movements in an economy. Estimates Of the rela- tionship between gross national product or total output Of an industrial sector and demand for services by a particular mode are Obtained by re— gression Of transport used on an economic output “indicator. The in- verted output elasticity Obtained assumas stability in relative sectoral output shares . The consignment approach to modal choice relies upon actual Obser- vation Of individual consignments . Information regarding the nature 81bid. , p. 23. 101 and characteristics of movement, charges, and service quality are col- lected for individual shipments. Probability models are estimated by regression techniques to show the probability Of selecting a particular mode and the relative influence Of the various modal attributes. ‘Sub- jective evaluations Of service qualities are used rather than actual figures since perception Of quality by decision makers determines modal selection. Studies Of this design in England have supported individual treatment Of commodity types and inclusion Of relative transport charges as a variable, for best results.9 Mbdal choice probability models have not given broad consideration to service quality Characteristics; typically the influence Of only physi- cal movement characteristics is treated. The regression.model developed fer the NOrtheast Corridor Project regressed.probability Of shipment by a particular mode upon commodity value per ton, freight rate and a set Of binary variables indicating shipment classification into consignment'weight. and movement distance categories. 1° . Estimation problems did not permit use. Of results in forecasting. Problems may have arisen due to lack Of confonm- ity in the ranges Of the dependent variable and.the error term. The logit fOrm Of the dependent variable has been used in a Dutdh study of commercial versus private motor carriage.11 Only the influences Of consignment weight and.movement distance were considered. There appears need to expand :modal choice probability models to consider the price and nonrprice deter- minants considered in conceptual approaches and revealed in market studies. This empirical technique bears the potential for estimating the 9Ibid., pp. 32, 61. 10Ibid., p. 68. lllbid., p. 69. 102 quantitative influence Of quality factors on demand for rail freight transportation. Quandt and Baumol have expanded the econometric approach to pre- dict demand for non-existent modes.12 New modes are described by speci- fying particular bundles Of travel characteristics which serve as new sets Of independent variables in modal demand.models. On the basis Of 'estimated.parameters Of service quality for existing modes, predictions Of quantity Of service demanded Of the new mode are estimated. The Interstate Commerce Commission under order _Ex Page NO. 270, "Investigation Of'Railroad Freight Rate Structure," is currently cen- ducting a study using the consignment approach. Individual shipments by a selected number Of firms will be surveyed to determine the influ- ence Of various factors affecting rail service demand. Tons shipped will be regressed on rail and truck rates, market price Of goods moved, total annual finm production, transit time, transit time consistency measured as a percent Of onrtime arrivals plus or minus one day, and inventory turnover rate.‘ The intent Of the investigatiOn is to deter- mine whether regulated freight rates are consistent with strong multi- modal competition. The generalized approach to transportatiOn planning treats trans- port demand as an element. Forecasts Of traffic flows by individual network links guide the priority Of investments. Meyer and Straszheim 12Richard E. Quandt and.WHlliam.J. Baumol, "The Demand for Abstract Transport Modes: Theory and.Measurement," Journal Of Regional Science 6 (1966), 13-26. 103 have developed a procedural volume for transport demand forecasting. 13 First, the future spatial pattern Of local economic activity is assessed by means of economic base studies. Estimates Of expected activity are converted to physical estimates Of traffic generated and terminated at ' different locations. Traffic originating and terminating at a particu-L lar location is distributed across regions adding the directional dimen- sion to traffic. Modes are selected and routes assigned revealing the total estimated demand for transport service by link and by mode. Care must be taken to assure prOper treatment Of relative prices Of commodi- ties between regions. Existence Of woodland does not insure a viable forestry industry. Trip generation must be representative Of the rela- tive value placed on products by local and external consumers. This procedure has been applied with a simulation technique in South America. 1" Derived Demand for Transportation Work previously done with transportation demand, just described, suggests a combination Of techniques to determine the market bound. A generalized approach to demand forecasting is called for to determine the stream Of traffic flow to be generated and terminated on particular“ line segments in question. TO estimate demand potential on particular lines, projection Of current traffic levels will not be sufficient. Service is urderstandably poor on some light density lines. TO urder- stand traffic potential at higher service levels, measurement Of demand 13John R. Meyer and Mahlon R. Straszheim, Prici and Project Eval- uation, Vol. 1: Techniques Of Transport Planni Was ngton, D.C.: :The Brookings Institution, 1971), pp. 99-109, 16 -181. 1"Paul O. Roberts and David T. Kresge, "Simulation Of Transport Policy Alternatives for Colombia," American Economic Review 58 (May, 1968), 341-359. 104 response tO various levels Of service quality is required. Such measure- ments will be particularly useful to local shipper organizations and governments seeking to determine a level Of service to contract for in subsidy transactions. 7 Freight transportation is not typically desired as an item Of final consurption. Rather, freight transportation is an intermediate input to production for which value is derived from the demand for final products at specific locations. As evidenced by research previously dited, each product Of transportation is a urique bundle Of many characteristics. These characteristics may be built into the model Of derived demand for railroad services similarly to the manner in which price is conventional- ly treated. ' For any firm g producing commodity i, assume a short rur production function exists, describing maximum output quantities. technologically feasible with various irput combinations, Of the general form rig = foh. xr. X,“ I 2%,) where yig = quantity Of output 1 produced by firm g, xh = quantity Of a composite variable plant irput, Xh’ xr = quantity Of railroad transport service, Xr, 3%“ = quantity Of motor transport service, )8“, and quantity Of a composite durable plantinput, Xp. *dx Quantities Of individual variable plant inputs composing the com- posite variable plant input, xh, are assumed to be the Optimum mix-Of resources used in the physical transformation process, given irput prices and fixed plant resources, 3%). This amounts to assuming the marginal 105 product per dollar Of each input used at the plant site is equal to that for every other input used. Transportation inputs, X r and )8“, inject time and place utilities into goods and services produced by the firm. A profit maximizing firm will maximize H=pif(xh’xr’xmlxp) -rhxh-rrxr-rmxm where pi is product price and rh, rr and rm are effective factor prices. Assuming a competitive product market and factor markets which are either competitive or regulated to provide constant prices, solution Of nec- essary maximizing conditions for the three unknown quantities Of inputs provides definition Of unique derived demand functions for variable plant and transportation irput flows, X1. = dhcpi’ rh’ Tr, rm) xr = dr(pi, r , rr, rm) xm = dm(pi, rh, rr, rm). Quantity demanded Of each input is dependent upon output price and the prices Of all inputs. A sufficient condition for profit maximization is that the profit function be rising at a diminishing rate, that is, be concave downward , which requires fhh hr fhm D = p1 frh frr frm <0 fmh fmr fmm 106 Effective transportation prices, r r and rm, include more than pub- lished transport rates. Effective prices are total costs incurred by consumers Of transport products due to use. Examples Of these added costs are inventory and storage costs associated with goods in transit, cost Of holding safety stocks as insurance against urreliable service, uninsured costs Of damage, and many others. Effective transport price may be looked rpon as the published rate rp plus the costs associated with a vector Of 11 service quality characteristics, rq. Thus, rl‘ = rrp + rrq(qr19 - ° ° 9 qm) rm_rmp+rmq(qml’ . . . ,qmn). The derived demands for transport services can now be represented as quality-price demand relationships, XI. = drtpi’ rh“ rrp’ rrqmrl’ ° 9 ° 9 qm)9 rmp9 rm(qm19 ° 9 ° 9 (111m)] Xm = dmlpi’ rh’ rrp’ rrchrl’ - - 9 9 qm)9 rmp9 rm(qm19 - ° ° 9 qmn)]- One can estimate the demand for rail and motor. freightservice with pro- duct price, plant factor price, and effective transport rates. The partial, derived, quality-price demand relationship may be pictured geometrically as in Figure 2 with quantity Of transportation service Of one mode on the horizontal axis and effective price on the vertical axis. The horizontal ray er represents the level of published freight rates which are at any moment fixed by regulation for all quan- tities Of service output. With zero consumption costs Of using trans- port Of the subject mode, that is, with "perfect" service characteristics, quantity Of service 00 will be demanded. However, as service worsens 107 Effective Price S P T 1* P : 0 Q Quantity of Service Figure 2. in the perception of demanders, cost Of consuming the service rises in- creasing effective transport price. Quantity demanded recedes along demand curve PS. Events which.would tend tO shift this demand curve are changes in relative service quality or price Of other modes, tech- nological change in the sUbject mode, or an autonomous change in pre- ferences by transportation users, such as a growing acceptance Of poorer and poorer quality as a fact Of life. To analyze the influence Of'a change in.effective price of railroad service upon quantity Of railroad service demanded, solve for change Of quantity demanded, dxr, by Cramer's rule, 108 f f dxr "" ‘1" ”P12 (’fh dPi " drh) rh m D . fmh fm f f +p.2 (-f dp. + dr) 11" 1"“ 1 r 1 r f f mh mm . j X f f 2 hh hm ‘pi ('fm dpi + drm) f f rh rm Assuming dpi = drh = drm = 0, the effect Of a change in effective rail transport price upon quantity demanded Of rail service may be isolated as 2 2 31:13.1. fhh fh'“ =p—1—(f f 2f) arr D f f D hh mm hm mh m where D is negative representing the rate Of change in slope Of the three dimensional isoquant. The terms fhh and fm are eXpected tO be nega- tive since rational production requires marginal productivities fh‘ and f m to be less than average productivities and marginal productivities are declining when below average productivities. Consequently, to“ Ob- serve an own price effect which is negative the following condition must hold, hhmm hm' 109 If motor transport service and variable plant inputs are substitutes, added truck service inputs would force marginal productivity Of the plant inputs down and fhmr‘ <0, easily fulfilling the condition for nega- tively sloped rail transport demand. If motor transport and plant in- puts are complementary, which is intuitively more appealing, fhm > 0 and the condition for a negative own price effect for rail transport ser- vices is sensitive tO the relative magnitudes Of the terms in the con- dition. If variable plant inputs and transportation services are being used near their extensive margins, rate of decline in marginal produc- tivities may be slight relative tO the degree Of cOmplementarity Of truck and plant inputs. ' In this case, rail service could be an extreme- ly inferior factor with an prardly sloped partial demand function. Assurption Of independence Of variable plant and transport inputs, fhm = 0, results in a negative own price effect for railroad service without question. Assuming rational producer behavior fhh’ fmm' < 0 and, D. <0, resulting in a negative own price effect. Effects upon rail transport demand of a change in effective price Of trucking may be isolated in similar fashion. Allowing dpi = drh = drr = 0 and using the definition Of dxr resulting from use Of‘Cramer's rule on total differentials Of necessary conditions for profit maximi- zation , 2 2 “(r-31— fhh fh’“ ——i f f -f f) arm D f f D hmrh hhrm ° rh rm A positive cross price effect reflecting increased railroad demand as truck prices rise requires that ff ff hh rm > hm rh ' If the marginal productivities Of plant irputs increase with addition Of either transportation input f , f rh > 0. If truck and railroad in- puts substitute for one another in production, frm‘ <0. Under these con- ditions one expects quantities Of railroad service demanded and effec- tive price Of 'trucking to move in the same direction if the rate Of de- cline in marginal productivity Of variable plant irputs times the degree Of substitutability Of rail for truck service is greater-than the pro- duct Of the rates Of increase in marginal productivities Of variable plant irputs as additional units Of each transport input are used. For rail service demand and effective motor carrier service price to move in the same direction and have complementarity Of truck and rail modes, f rm > 0, one and only one Of the modal transport irputs would have tO cause a decline in marginal productivity Of variable plant in- puts with larger quantities Of the transport input and still satisfy the condition f f f > hhrm hmrh' Assuming variable plant and transport irputs are independent in production processes 111 2 dxr ,__ pi fhh frm Under this independence assumption and the assumption Of rational pro- ducer behavior, implying fhh' < 0 and D < 0, cross-price effects are pos- itive or negative as truck and railroad services are substitutes or com- plements, respectively. One final task is to isolate the effect Of an incremental change in a single quality Of service variable upon quantity Of rail service demanded. Recall that effective railroad transport price is rr = r1.p + rrchrl’ . . . , qm). Assume a change in level Of railroad quality characteristic qm Of mag- nitude dqm such that 6 r drr = gig-E- dqm . Holding published rail rate, levels Of other railroad quality character- istics, effective motor carrier price, plant input prices and product price constant, total change in quantity Of railroad service demanded in consequence tO the quality change becomes éxrdr =_Hauuounu ence Haeoupuasm mucoEmEm p558: ”Smog. Sham :Owumuwfiuonw mo mpgmom .NH mqmfi. 134 space regarding functional form Of quality-demand relationships for inbound shipments. At least some evidence, is provided in support Of fur- ther tests Of these two functional forms using other data samples. The possibility always exists that more than one functional form will serve to represent a population. Finally, the logit form Of the modal selection probability model was subjected to Specification error tests. Results appear in Table 13. TABLE 13. Results of Specification Error Tests: Outbourd Modal Selection Probability Critical Value Logit Null Test Form 5% 10% , Hypothesis RESET F3,7 3.0993 4.35 Accept RASET t9 0.8199 2.26 1.83 Accept BAMSET xg 3.2313 5.99 4.60 Accept WSET Dn 0. 3495 Accept R2 0.3085 98,11 0.4461 2.95 While R2 and F statistics do not reveal significant explanatory power with preliminary data, specification error tests provide no evidence that the logit-linear functional form is inappropriate. The final area Of concern is the sample data used tO estimate quality-demand and modal selection probability models. Data were accum- ulated from individual firms in various industry grorps using a mail questionnaire survey. The questionnaire, distributed as the Michigan Freight Transportation Survey by the Michigan Department Of State 13S Highways Of Transportation, is available for review in Appendix A. The questionnaire contains three batteries Of questions relating to inbourd and outbound movement and quality Of service characteristics and firm characteristics, for the year 1973. Movement and quality Of service, characteristics were collected for both motor and railroad modes. Various industry groups were surveyed. For industry groups with many members, a random sample Of firms was selected for participation from the most complete, available list Of membership available. For industry groups including few individual firms, the entire population was asked tO participate. Two mailings Of the questionnaire instrument were performed tO enhance the proportion Of returns; the first was mailed May 1, the second June 15, 1974. Those returned for faulty address or lack Of forwarding address were deleted frOm the sample. Data are not Of eSpecially high quality. One Objective Of the Michigan Freight Transportation Survey was to Obtain broad public par- ticipation in the transportation planning process. Completion Of a vast number Of questionnaire instruments was, consequently, unsrpervised. Information received varies broadly in quantity and quality among indus- try groups. Some responses are clearly estimates; others contain exact figures from business records. Only data on inbound feed and fertilizer movements and outbound grain movements to and from Michigan grain ele- vators and farm stores were Of sufficient quantity and quality to esti- mate quality-denand and modal selection probability models. 5 For other} industry grOtps surveyed, simple proportion means serve to provide esti- mates Of modal split. Attempts to estimate transportation demand 136 relationships in the manufacturing sector were wholly abandoned for lack of response to the data collection procedure?2 Regression Results Unit, index and logit probability forms Of the dependent variable were regressed on a linear function Of firm, movement and quality charac- teristics Of transportation by means Of the ordinary least squares tech- nique. Data Of sufficient quantity and quality permitted complete analy- sis Of only three commodity grOLps. Considered are outbound grain ship- ments and inbound feed and fertilizer movements originating and terminat- ing at Michigan grain elevators and farm supply stOres. The null hypo- thesis in each estimate is that all true population parameter values equal zero. Sample size was limited by data quality to small numbers Of Observations in each estimate. Small samples Of microeconomic data typically harbor great variability under the best Of circumstances. NO steps were taken to enhance the efficiency Of estimators. I Regression on complete models incorporating all previously mentioned variables revealed active presence Of multicollinearity problems. Sev- eral complete estimates displayed significant F statistics with no sig- nificant coefficients or constant term. Parameter estimates derived from estimators with multicollinearity are unbiased, but inefficient. TO enhance efficiency Of estimators, the data correlation matrix was reviewed to ascertain which pairs Of variables represented close associ- ations. Since two highly correlated variables may Often be represented 22Marc A. Johnson, The Michigan Freight Transportation Survy: An Investigation Of Modal Split, Report to the Railroad Planning Section, Michigan Department Of State Highways and Transportation, Lansing, Michi- gan, November, 1974 (Lansing, Michigan: Michigan Department Of State Highways and Transportation, 1974) . 137 by a single variable, estimators were formed with successive deletions Of several highly correlated variables. Where parameter estimates do not change grossly and.where efficiency measures improve, valid inter- pretation with deleted variables is possible. Where parameter estimates change substantially or efficiency measures deteriorate, variable de- letion is not a valid procedure, for the variable may represent suffi- ciently independent influence upon the dependent variable tO-cause bi- asedness Of other estimates when removed. .A second adjustment involved deletion Of the variable most limit- ing data quantity. The purpose Of this alteration is to enhance esti- mator efficiency by increasing sample size. Where parameter estimates are only marginally affected and where efficiency measures improve, the procedure produces valid estimates. Where parameter estimates change greatly upon removing a variable, the variable is important to the eSti- mator and deletion produces inconsistent estimates. Regression results Of complete and adjusted estimators are provided for both index and linear forms Of quality-demand.models and the logit- 1inear fOrm Of the modal selection.probability model. Recall that for outbound grain shipments, the index functional fOrm was fOund tO be superior tO the linear functional form. Outbound Grain Shipment: Index Form Regression results Of the quality-demand relationship fOr outbound grain.movements from Michigan grain elevators using the index model fOrm.are shown in Table 14. The dependent variable is the logarithm Of tons shipped by railroad. Individual regression coefficients are inter- preted as the percent change in railroad service demanded due to unit TABLE 14. Bed-to Comm Visits Railroad Visits 138 Index Functional Form: Outbound Grain Movements 1 4.370290“ (1.050975) -0.000449 (0.001498) -0.000002 (0.001003) -0.312510 (0.694461) -0.0$5693 (0.572050) -0.011850 (0.020222) 0.055727 (0.170227) -0.018112 (0.023410) 0.070268 (0.192293) -0.013010 (0.018442) 0.010952 (0.026202) 0.078923 (0.150671) 0.001201 (0.008970) 0.493022 0.8109 1.7873 0.271 18 2 4.470605“ (0.968879) -0.000836 (0.001222) 0.000501 (0.000268) -0.040744 (0.432808) 0.035669 (0.510806) -0.015194 (0.017990) 0.020084 (0.146297) ‘0.025807 (0.017089) 0.105009 (0.169227) -0.015732 (0.016591) 0.010425 (0.024548) 0.004163 (0.006528) 0.462249 0.8006 2.1897 0.174 18 3 p 4 4.357191“ 1 4,470163“ (0.908728) (0.790074) -0.000752 -0.000765 (0.001160) ;(0.001092) 0.000531 0.000513 (0.000252) . (0.000232) -0.110855 41.116519 (0.399026) (0.375650) 0.175292 0.212477 (0.437972) (0.398141) -0.009621 -0.008610 (0.014887) (0.013714) 0.043513 (0.134989) -0.021129 -0.022497 (0.014647) (0.013210) -0.005731 -0.004823 (0.003763) (0.002348) 0.009564 0.006373 (0.023408) (0.019987) 0.002301 0.002103 (0.005538) (0.005186) 0.441478 0.416018 0.7878 0.7846 2.5984 3.2383 0.109 0.056 18 18 5 .Lwnnu . (0.847778) " -0.00u09 .. (0.001008) ‘ 0.000501 (0.000565) -0.055512 (0.271287) 0.448088 (0.331761) 0.003078 (0.001988) -0.053344 (0.081561) -0.019675 (0.013151) -0.064201 (0.053322) 0.002816 (0.006540) -0.017374 . (0.015440) 0.011119 (0.062250) 0.518393 0.6108 2.1399 0.086 25 6 4.397941“ (0.836268) -0.000665 (0.001075) 0.000544 (0 . 000259) 0.055284 (0.296289) 0.279526 (0.368867) -0.009838 (0.009483) -0.029969 (0.080636) -0.020322 (0.012685) -0.046853 (0.054168) 0.000681 (0.006651) 0.002417 (0.020880) 0.500441 0.6489 2.5877 0.051 {25 Regression Results Of the Quality-Demand Relationship in 7 4.356420.. (0.827850) -0.000495 (0.001048) 0.000592. (0.000251) 0.031143 (0.292485) 0.120834 (0.317305) -0.013192 (0.008581) -0.019691 (0.079083) -00021650 (0.012486) -0.004390 (0.003115) 0.006068 (0.020276) 0.496222 0.6302 2.8397 0.036 25 139 changes in movement, firm.and.quality Of service variables. Estimator characteristics are summarized at the bottom Of the table. The estimator including all previously mentioned independent vari- ables, equation 1, does not perform well. Influences Of railroad.pro- motional effort, truck damage and delays in motor freight equipment de- livery were successively removed from analysis. Correlation coefficients fOr these highly related variables are reported in Table 15 fOr limited and expanded samples. Since the relationships between unreliable motor carriage disappear in larger samples, the truck delay variable was not removed with the larger sample. TABLE 15: Correlation Coefficients for Highly Related variables for Outbound Grain Shipments. “—11 Sample Size Relation 1 n 3718 n = 25 Railroad Visits and Storage Capacity .944 .942 Truck Damage and Railroad Damage .980 .864 Truck Delay and Truck Damage .744 .395 Truck Delay and Railroad Damage .730 .473 The variable limiting data quantity, railroad transit speed, was deleted tO permit estimation with larger sample size. The R2 delete statistic Of this variable in the initial regression was 0.8103 where the model R2 = 0.8109. Removal Of railroad transit speed does not radi- cally affect coefficient estimates, while increased sample size appears tO give the model more Of a chance to reveal its power. For a given sample size, successive deletion Of highly associated “variables reduces standard errors Of estimates slightly, though standard 140 error is not reduced by enlarging sample size by the described.procedure. Adjustments also erode the proportion of variation explained by inde- pendent variables. HOwever, model adjustment does provide a basis for improving reliability Of estimates in that the F statistic enlarges, be- coming significant at the five percent confidence level in equation 7. Though only size Of firm appears a reliably significant determinant, the trend Of significance level Of Student's t-statistics Of two quality variables is worth noting. As estimator 7 reveals, an increase (decrease) Of 100,000 bushels in storage capacity results in a five percent in- crease (decrease) in quantity Of railroad service demanded. Two quality Of service variables, while not yielding statistically significant influence, may be worth further study with other data samples of greater quantity and quality. Levels Of significance Of Student's t-statistics fOr three variables are shown in Table 16 for the seven index form estimators. Delay in delivery of railroad cars approaches the 10 percent sig- nificance level as the estimator is adjusted for multicollinearity and sample size. The coefficient on this variable remains stable through- out estimator adjustments, but standard error Of the coefficient esti- mate continually declines. The coefficient may be interpreted as fol- lows. Each day added to average delay in receiving railroad cars causes shippers to demand 2.2 percent less railroad service. The influence Of damage and loss associated with railroad shipment may be an important factor in quantity Of railroad service demanded. Significance Of this influence depends upon.whether the variable Of truck damage is included in the model. When truck damage is excluded from the estimator, railroad damage appears potentially important. .A 141 strong conclusion cannot be made to favor this result. Isolation Of truck damage and railroad damage effects upon railroad demand will re- quire a different specification Of these variables. TABLE 16. Levels Of Significance Of Student's t-Statistics for Coefficients Of Three Potentially Important Rail Service Demand Determinants: Index Form Of Outbound Grain.Quality-Demand FUnction. Estimate 1 2 3 4 5 6 . 7 Storage .998 .111 .073 .058 .389 .054 ..0325 Capacity Railroad .474 .182 .192 .127 .155! .131 .103 Delay ' Railroad .512 .380 .172 .074 .673 .920 .179 Damage Mbdel F .271 .174 .109 .056 .086 .051 .036 Statistic Sample 18 18 18 18 25 25 25 Size Outbound Grain Shipment: Linear Fonm Results Of the linear functional fOrm estimators for outbound grain shipments are shown in Table 17. The dependent variable is the absolute number Of tons shipped by railroad. This functional form was previously determined by specification error tests tO yield biased estimates. Re- gression Of the complete estimator results in a high.mu1tiple correla- tion coefficient and a significant F statistic at the five percent con- fidence level. Estimator adjustments for multicollinearity and sample size result in reduced standard deviation Of estimates and larger, more“ significant F statistics. The multiple correlation coefficient is erod- ed little throughout estimator adjustment. The linear form suggests '114081313 1177. constant Railroad Distance Storage Cipacity Lease Percent Divert Delay Railroad Delay Dllnge Railroad Visits Railroad Visits Railroad Standard Error F Stat. Signif. Sample 1 2920.6151 (14938.7961) 20.7386 (21.2870) 15.0196 (14.2524) -13938.2519 (9871.2223) -2906.2969 (8131.2552) -l3.6934 (287.4333) 512.9107 (2419.6514) 0.5923 (332.7487) -1305.0931 (2733.3013) 120.9996 (262.1440) -56.7927 (372.4365) 2475.8178 (2141.6704) -7Z.7589 (127.4959) 7007.9225 0.9586 9.6503. 0.011 18 2 6067.4921 (15094.8265) 8.6079 (19.0330) 30.8105“ (4.1797) -5412.9101 (6743.0195) -40.ZS38 (7958.2007) -118.S777 (280.2795) -605.2044 (2279.2569) -240.8010 (266.2357) -215.2541 (2636.5099) 35.6193 (258.4792) -73.3229 (382.4522) 20.1495 (101.7115) 7201.6917 0.9475 9.8537.. 0.005 18 3 6299.9761 (13731.7998) 8.4350 (17.5214) 30.749288 (3.8087) -5269.1918 (6029.6894) -326.4612 (6618.1980) -130.0021 (224.9603) -653.2308 (2039.8252) ~250.3902 (221.3269) 15.1198 (56.8581) -71.5590 (353.7128) 23.9650 (83.6842) 6671.1730 0.9475 12.6307“ 0.001 18 1112 Outbound Grain Movements 4 4603.9968 (11937.6781) 8.6381 (16.4986) 31.010188 (3.5056) -5184.l683 (5675.9134) ~884.7074 (6015.7330) -14S.169S (207.2159) -229.8540 (199.5979) 1.4763 (35.4782) -23.6440 (301.9965) 26.9463 (78.3612) 6285.8562 0.9467 15.7946“ 0.0005 18 5 12878.1165 (10005.4341) -12.2139 (11.9022) 37.705288 (6.6720) -867.5292 (3201.7175) 7839.1652 (3915.4338) 43.9469 (23.4621) -49.1356 (962.5789) -201.2426 (155.2081) -7ZS.309S (629.3069) 75.6299 (77.1880) -203.8124 (182.2245) -1087.l605 (734.6742) 6118.0532 0.9119 14.1209“ 0.0005 25 6 8663.4177 (9097.6491) -2.3615 (11.6981) 31.0398“. (2.8177) -4250.7044 (3223.2912) 3444.3511 (4012.8501) -33.5500 (103.1643) 165.6620 (877.2310) -140.9693 (137.9978) -269.8997 (589.2855) 26.3393 (72.3572) -ss.39s7 (227.1497) 5444.2315 0.9349 20.109088 0.0005 25 Regression Results Of the Quality-Demand Relationship in Linear Functional Form 7 8424.2300 (8840.1666) -1.3789 (11.1927) 31.315188 (2.6794) -4389.7684 (3123.2888) 2530.1889 (3388.3249) -SZ.8744 (91.6286) 224.8722 (844.4891) -l48.6159 (133.3271) -2.8728 (33.2587) -34.3582 (216.5182) 5298.8857 0.9339 23.561388 0.0005 25 143 that only firm size plays an important role in quantity of grain shipped. The coefficient on firm size remains stable throughout estimator adjust- ment. Estimator 7 may be interpreted that every change in storage ca- pacity by 1,000 bushels of space is likely to produce 31.3 tons change in railroad service demanded, or slightly less than one-third of a covered hopper car. Bnpirical measures of service quality influences upon quantity of railroad service demanded do not resemble the intensity with which these factors are mentioned in market research and ICC railroad abandonment hearings. Quantity of railroad service demanded by individual grain elevators for outbound grain movements is nearly exclusively determined by firm size. Outbound Grain Shipment: Logit Form Estimates of modal selection probability for outbound grain move- ments are shown in Table 18. The dependent variable, is the logarithm of the ratio of tons shipped by railroad to tons shipped by motor car- rier. Results are not anticipated to resemble those for quality-demand estimates. The complete modal selection probability estimator, including all potentially influential variables mentioned, appears useful, despite inefficiency caused by multicollinearity. Nearly 98 percent of varia- tion in the dependent variable is explained by the independent variables and the F statistic of joint significance of coefficients is highly sig- nificant. Of the highly correlated independent variables, only the truck damage variable appeared to have no influence upon modal selec- tion. Deletion of the truck damage variable causes no major changes in TABLE 18. Relationship : Bstinate constant Railroad Distance Storage Capacity Own Truck Lease Car Percent Divert Delay Railroad Delay Truck IDamage Railroad Damage Visits Railroad Visits Railroad Speed Standard Error Psun. Signif. Sample 144 Regression Results of the Modal Selection Probability Outbound Grainlevements 1 0.801779* (0.248907) 0.001167* (0.000355) -0.001541“ (0.000237) -0.518680* (0.164472) -0.151753 (0.135481) -0.002490 (0.004789) -0.179436* (0.040316) 0.001841 (0.005544) -0.095229 (0.045542) 0.012670* (0.004368) -0.023181* (0.006205) 0.227324** (0.035684) -0.010704** (0.002124) 0.116765 0.9773 17.9455** 0.003 18 2 0.925106* (0.302231) 0.000974 (0.000428) -0.001401‘* (0.000285) (0.186498) -0.233516 (0.162122) -0.008032 (0.004985) -0.209778** (0.047011) -0.004406 (0.005837) 0.003792* (0.001282) -0.022665* (0.007750) 0.201588** (0.041862) -0.008251** (0.002213) 0.145935 0.9575 12.2783** 0.003 18 14S coefficient estimates, though estimate error, R2 and the F statistic worsen. Since the variable limiting data quantity appears significant, the element could not be removed to allow use of a larger sample size. Equation 1 of Table 18 suggests that there exist nunerous move- ment, firm and service quality characteristics which affect modal selec- tion. Three movement and firm characteristics and five service quality characteristics appear to influence modal split. Estimator 1 suggests that for an increase in average distance to railroad markets of 100 miles, the proportion of rail to truck shipment increases by nearly 12 percent. This may be explained by a declining substitutability of truck for rail service for longer distance distribution patterns. Firm size and ownership of trucks affect the proportion of modal service used. Larger firms tend to place greater reliance upon motor carriage than do smaller grain handlers. As storage capacity of an ele- vator increases by 10,000 bushels, the proportion of rail to truck shipment is only half that of firms not owning trucks. This result may imply scale economies in truck ownership which allow larger firms to command a truck fleet. Snaller firms, then, may be left to the mercy of railroad service. This result also may imply scale economies in management. Larger firms may emphasize maximization of throughput volume requiring use of trucks to enhance flexibility in use of storage capacity. Isolation of the behavior implied by these results will re- quire further study of transportation users. Quality of service characteristics influence modal split in ways not all of which are intuitively appealing. As the informal market study of Michigan shippers revealed, individual shipper firm contact by transportation companies is important in modal selection. One visit 146 by a trucking firm will decrease the ratio of railroad to truck use by 2.3 percent holding other influences constant. One visit by a railroad firm will increase the ratio by nearly 23 percent, holding other varia- bles constant. Promotional contacts by railroad firms are few and there may exist diminishing returns to more and more effort. However, at these low levels of effort, personalizing railroading may have high payoff from grain elevators. Other quality of service results are less intuitively appealing. The more unreliable is delivery of trucking equipment or the faster is railroad service, the smaller is the relative amount of railroad service used. Too, the greater the incidence of damage and loss associated with railroad shipment, the greater is the proportional reliance upon railroad service. Each result is isolated from other influences. The relative preference for slower service may conceivably reflect use of railroad cars as storage containers for shipments of undetermined destination. A.prevalence of selling grain while in transit may cause such a result. The sign on the coefficient would be expected to reverse itself at low levels of speed.which.may threaten.product quality. Reasons for re- gression results for railroad transit damage and sluggish trucker re- sponse are unclear. Inbound Fertilizer Shipment Estimators of quality-demand and.modal selection probability relas tionships for inbound shipments provide evidence that the importance of individual service quality factors varies between commodity types. Re- sults for fertilizer deliveries are shown in Table 19. The first two equations display results of the index estimator ferm.with the logarithm of railroad tons received as the dependent variable. Equations 3 and 4 TABLE 19 . Probability Relationships: t variable Estimate Constant Railroad Distance Employ. lease Railroad Damage Damage Railroad Inventory Rate Ratio Standard Error R2 F F Stat. Signif. Sample Index Bonn l 2 2.133493“ 2.169780‘* (0.679766) (0.322113) -0.000770* -0.00043l (0.000292) (0.000278) 0.031672** 0.030506" (0.004725) (0.005071) 0.085182 -0.204794 (0.434177) (0.283835) -0.128189 -0.105153 (0.271365) (0.267292) 0.003878 0.003566 (0.005880) (0.005979) -0.000896 -0.002584 (0.007848) (0.008238) 0.011912** 0.011340** (0.003890) (0.003983) 0.018732 0.012648 (0.008745) (0.008305) -0.308322 (0.275883) 0.358695 0.406390 0.8904 0.7731 11.7387 10.2238 0.0005 0.0005 23 33 147 Linear Form 3 4 (36006.8790) (12711.8002) 0.4501 2.3059 (15.4774) (10.9870) 1874.4038‘* 1842.1435“ (250.2664) (200.1306) 132.6793 -7629.7256 (22998.1459) (11201.2009) 14865.4232 6830.9891 (14374.0868) (10548.3633) -205.8694 -231.1959 (311.4447) (235.9544) 264.9380 267.6567 (415.7200) (325.0849) -l46.4386 -186.9197 (206.0428) (157.1713) -437.9309 ~47S.1079 (463.2158) (327.7589) 5838.6891 (14613.3750) 18999.8954 16037.7098 0.8727 0.8355 9.9048 15.2344 0.0005 0.0005 23 33, Regression Results of Quality-Demand and Modal Selection Inbound Fertilizer Movements Logit Form 5 6 0.752477 -0.061172 (1.037642) (0.550282) -0.001093* -0.000466 (0.000446) (0.000476) 0.019046* 0.016878 (0.007212) (0.008663) -0.8S3754 -0.602239 (0.662758) (0.484889) 0.012849 0.187394 (0.414231) (0.456628) 0.017126 0.010651 (0.008975) (0.010214) ~0.0ll454 -0.010792 (0.011980) (0.014073) 0.010109 0.008459 (0.005938) (0.006804) 0.015095 0.011428 (0.013349) (0.014188) -0.830186 (0.421126) 0.547537 0.694257 0.7035 0.3792 3.4279 1.8326 0.022 0.120 23 33 148 provide results of the linear estimator form. Specification error tests support only slight preference for the index form of the estimator. Both index and linear estimator ferms provide a high degree of joint significance among parameters. Nearly ninety percent of variation in dependent variables is explained by the empirical models. Adjustments to enhance estimator efficiency do not improve properties of the index estimator form and only slightly improve properties of the linear esti- mtor. Three pairs of variables are highly correlated. The railroad to truck ratio of freight rates and distance to railroad.markets are in- versely related with correlation coefficient r = -0.733. Freight rate ratio and railroad speedand distance to railroad markets have correla- tion coefficients of 0.800 and 0.832 in limited and adjusted‘sample sizes, respectively. Adjustment for multicollinearity by variable deletion is not feasible with the index estimator form, for highly asso- ciated variables reveal significant coefficients of relationships. Similar adjustment for the linear form provides only marginal improve- ments in estimator properties. The index estimator form of quality-demand relationship for inbound fertilizer shipments suggests three important determinants of railroad . use. First, distance of supply sources from final distribution centers affects tons of fertilizer shipped.by railroad. Equation 1 reveals that every hundred.miles added to the average distance of supply points re- duces amount shipped by 7. 7 percent. This result may be interpreted either as a phenomenon of transportation cost friction in interregional trade or evidence of more and more intervening opportunities as supply points become more distant. 149 Firm size, measured by nunber of full time employees, appears a highly significant determinant of the amount of fertilizer an individual firm will receive by rail carrier. An increase in plant size which is indexed by an increase of one full time employee is accompanied by an increase in fertilizer receipts of 3.2 percent.- The sole service quality variable which appears to influence in- bound fertilizer shipments is railroad speed. Faster service stimulates increased railroad shipments. An increase in average daily speed by one mile results in a 1.2 percent increase in fertilizer shipments by railroad. The estimator of linear form suggests that only firm size deter- ' mines volume of fertilizer shipments by railroad. - An increase in firm size requiring one additional full time employee is accompanied by an increase in nearly 1,900 tons, or nearly twenty hopper cars, of fertili— zer receipts by railroad, holding other potential influences constant. The logit-linear estimator of modal selection probability also shows quality of service variables to be ineffective determinants of modal split behavior. Results of modal selection probability estima- tion are provided in equations 5 and 6 of Table 19. Only the unadjusted estimator has properties which permit interpretation (equation 5). Only railroad distance to supply points and firm size affect the ratio of railroad to truck shipments of fertilizer. Increases in distance between supply points and distribution centers of ten miles result in reductions of rail to truck ratio of fertilizer delivery by 1.1 percent. Recall that absolute quantity of fertilizer drawn from railroad markets declined with greater distance. EVidently 150 intervening opportunities do exist for substitution of truck for rail- road delivery. Truck delivery of fertilizer from.ports on the Great Lakes provide these opportunities. Though unit costs of these deliveries are higher than for railroad deliveries over comparable distances, short distance truck shipments appear to compete effectively with very long distance railroad.movements. Larger firms ship proportionally more fertilizer by railroad than do smaller firms. An increase in firm.size by one employee increases rail to road fertilizer delivery by 1.9 percent. Inbound Feed Shipment Results of railroad demand estimates for inbound feed shipments to Michigan elevators and farm.stores are shown in Table 20. The index estimator form is shown in equations 1 and 2 and the linear form in equations 3 and 4. With both forms more than 95 percent of variation in the dependent variable is explained by firm, movement and quality characteristics. There are two pairs of highly correlated variables. Truck damage and railroad damage have correlation coefficients of 0.865 and 0.864 for limited and adjusted.sample sizes, respectively. Inefficiency caused by this association cannot be remedied, fer both variables have signifi- cant regression coefficients. Railroad transit speed and railroad distance have correlation coefficients of 0.549 and 0.707 for limited and adjusted sample sizes, respectively. Railroad distance is deleted to improve estimator efficiency. The variable limiting data quantity is the ratio of railroad to truck freight rates. Removing freight rate ratio information from the TABLE 20 . Ikpendant variable Estinate Constant Railroad Distance ' WIWO Own Truck Lease Car Railroad Danage 1ru¢k Illnce Railroad Speed Inventory Days Rate Ratio Railroad Rate Rate Standard Error 88am. Salple Index Ron- 1 2 2.3594949 2.475405‘* (0.441611) (0.399858) 0.001132 (0.000568) 0.000077 0.010154 (0.009512) (0.010581) 0.793366 0.326742 (0.281709) (0.333338) 0.370465 -0.127565 (0.242576) (0.274343) 0.0154379 0.0122989 (0.003221) (0.004711) -0.050830' -0.030340 (0.011695) (0.015403) -0.012056 0.001659 (0.005289) (0.004371) -0.014330* -0.007370 (0.003907) (0.004996) 0.245135 (0.244256) 0.215449 0.382164 0.9537 0.5447 6.8691 2.5636 0.070 0.060 13 23 Linear‘RonI 3 4 -405.2568 357.1816 (744.4850) (507.8409) 0.7516 (0.9574) 19.4023 28.1439 (16.0364) (13.3263) 795.4205 492.3614 (474.9156) (311.7786) -62.3057 -l62.8048 (408.9448) (272.6984) 29.1132. 31.246999 (5.4305) (4.4254) -58.7880 -60.9383‘* (19.7165) (15.0504) 3.0535 8.1243 (8.9159) (6.5775) -12.4788 -8.8274 (6.5871) (6.0234) 310.8874 (411.7769) -10.0729 (12.9414) -3.0602 (5.0544) 363.2114 284.5390 0.9658 0.9790 9.4242 15.5658 0.046 0.023 13 13 151 Inbound Feed.M0vements 5 -0.245093 ~(1.046549) 0.001461 (0.001346) (0.022543) 10“”28 (0.667606) 0.481488 (0.574868) 0.007716 (0.007634) -0.046735 (0.027716) -0.023119 (0.012533) ~0.034302‘ (0.009260) 0.400495 ' (0.578850) 0.510579 0.8962 2.8769 0.208 13 Logit Bonn 6 -0.188683 (0.631456) 0.000397 (0.000915) -0.017743 (0.015624) 0.886147 (0.526713) 0.025901 (0.426250) 0.004156 (0.006890) -0.017361 (0.022858) -0.009655 (0.008698) -0.023980*‘ (0.007226) 0.552793 0.5920 2.5396 0.061 23 Regression Results of Quality-Demand and.Mbdal Selection Probability Relationships: 7 -0.078819 (0.562514) -0.016380 (0.014885) 0.794229 (0.468935) -0.041567 (0.385942) 0.003713 (0.006627) -0.015148 (0.021669) 40.007065 (0.006149) -0.023980“ (0.007028) 0.537623 0.5866 3.0401 0.034 23 152 estimator results in increased standard errors for estimates and sub- stantially reduced explanatory power. However, joint significance of the parameters improves with larger sample sizes. The index estimator form does not show strong joint significance of the eiqalanatory variables. Damage in transit by truck and rail modes and inventory stocks appear potentially important determinants of de- mand. The linear estimator form possesses superior properties of ex- planatory power and joint significance of parameters. iSample size ad- justment with removal of freight rate information makes the linear esti- mator unusable. In transit damage by both modes again appears impor- tant in determining quantity of railroad feed shipments. Modal selection probability estimators for inbound feed shipments are shown in Table 20, equations 5-7. Throughout adjustments for multi- collinearity and sample size, estimators revealed that only inventory capacity affects the relative proportion of modal selection. Estimator 7 suggests that as ability to operate from inventories increases by one more day, the ratio of railroad to motor carrier use declines by 2.2 percent. Intuitively one might expect to observe firms with greatest inventory flexibility placing greater reliance upon slower, less reli- able modes. The observed results may be interpreted in one of two ways. Most feed shipments arrive from a small number of origins in northern Indiana. Given that other influences are held' constant, one may conclude that for feed shipment, trucking provides less reliable delivery service than do railroads. Another explanation for the inverse relation between inventories and relative preference for railroad service is a short run, cyclical phenomenon. The year 1973 was characterized _by rapidly rising feed 153 prices and interest rates. The negative relationship may reveal an attempt by firms with large inventories to liquidate stocks to more closely manage inventory costs. The draw down of inventory stocks would require smaller inbound volumes which are more reasonably hauled by motor carriers. Evidence for such an explanation is not conclusive. Further study is warranted to explain“ the cause of the measured in- fluence of inventory stocks upon modal split. Sumnary Fertilizer and feed are quite different conmodities with respect to transportation. Fertilizer is a conmodity chiefly purchased in bulk form for seasonal use. Consequently, speed is the quality characteris- tic of transportation which is important to meet narrow schedules of seasonal market demand. Fertilizer components are products of basic extraction activities. These commodities are of a bulky, low-value-I per-unit nature. Transportation costs are a major element of total fertilizer value. As a result, distance to supply points is an impor- tant determinant of demand. Due to the system of distribution estab- lished in the fertilizer market, truck shipments of plant food from lake ports serve as intervening opportunities to long distance overland movements. Feed, on the other hand, enters Michigan in bagged form for sale throughout the year. Supply points are located closeby in the midwestern region. Unlike bulk fertilizer, bagged animal feed is susceptible to damage in transit through breakage. Consequently, amount of damage as- sociated with particular modes affects the quantity of service demanded Of those modes. 154 Regression results support the conclusions of two British studies of modal selection, reported by Bayliss. Those investigations suggested that commodities should be given individual treatment and that modal freight rate ratio be included in regression analysis. Differences in results for inbound feed and fertilizer movements suggest that‘as supply and.product market characteristics and physical characteristics of in- dividual commodities differ, importance of various service quality factors also differs. The importance of including the freight rate ratio is shown in Tables 19 and 20. For nearly all inbound railroad demand estimators, deletion of the freight rate ratio variable increases standard errors of estimates and deteriorates explanatory power, despite larger sample sizes permitted. The ratio of freight rates did.not show a significant influence on.quantity of railroad service demanded or modal split, after other influences were considered. However, freight rate ratio appears an important element of the-estimator, especially fer'prediction.purposes. Regression results reveal that the index.ferm.of'quality-demand relationships isolates several important railroad service demand deter- minants, even with small samples of microeconomic data. Estimated parameters must be used with extreme caution. Data used in specifi- cation error tests of functional form were included in the samples used fer estimation. Paucity of data prohibited separation of the data sets. consequently, parameter estimates are derived from regression on equa- tions with functional forms tested with a portion of the data used to, make actual estimates. Further studies with new data are suggested to derive independent estimates using results of specification error tests as prior infbrmation. 155 Market research and tes timony before ICC abandonment hearings have suggested that quality of service has a major impact upon quantity of railroad service demanded. Results of regression on quality-demand and modal selection probability models reveal that service quality may well affect railroad service demand, but not to the extent suggested. The difference between vocal complaint and action can be explained by the concept of economic action thresholds. Kolsen's shipper utility model approaches this type of explanation. While a shipper may be inconven- ienced by relatively poor service of the railroad mode, Operating costs associated with poor service quality may not exceed the difference be- tween published railroad and motor carrier freight rates. Given a par- ticular firm output level, the less costly transportation mode may de- crease service quality until effective price of consuming services equals the effective price of the next least expensive mode. Only at this level of service deterioration will the shipper have reached an econo- mic. action threshold which causes a change in modes. However, an increase in effective price of the least cost mode will tend to raise marginal costs of production to the shipper firm. To the extent that quality of service deterioration causes reductions in plant outputs in reaction to increased marginal production cost, quantity of railroad service demanded may decline slightly for each de- crement in service quality. Infancy of railroad service demand estimation has required spend- ing available data on basic development of statistical experience with. quality-demand and modal choice probability functions. Estimators do not bear qualities required for inclusion in a detailed traffit fore- casting model. New, independent data samples would be required. 156 Bnpirical demonstration of branch line analysis, contained in Chapter VI, will rely on conventional trend projections for traffic forecasting. Further data base development will, in time, enable more sophisticated traffic forecasting procedures which consider contracted levels of ser- vice quality. The market bound to provision of branch line service is nearly com- plete. Willingness and ability of individuals to pay for external ef- fects associated with presence of a line areconsidered in the next chapter. Values external to consideration by railroad management may expand the market bound by means of private collective action. Other external values add to the market bound to establish the social bound to railroad branch line service provision. CHAPTER'V THE SOCIAL BOUND Governments of societies which offer citizens opportunity to make their own major decisions, serve as collective producers and market re- gulators to adjust market perfbrmance for external effects of private action or inaction. External effects are influences of one actor upon another for which account is not taken in decision processes. To the extent market adjustments can be made by compensatory agreements between individuals or between groups of individuals in collective action, the adjustments are an extension of the market bound. For economy of dis- cussion, consideration of external effects has been-reserved for develop- ment of the social bound. The Regional Rail Reorganization.Act of 1973 has provided states, commmities and shipper groups an opportunity to subsidize local rail- road operations. A.chief Objective of this researdh is to provide cri- teria and procedures with which state and local agencies may evaluate railroad branch line investment alternatives. Two questions arise. Do benefits of continued line operation exceed opportunity costs of pro- vision? If so, who is to bear these costs? First, a criterion will be established by which to determine net benefits. Secondly, consideration will be given to who might bear the costs. The limits of'market and public action will be distinquished. The social bound to production and investment encompasses both.market recognized and external benefits and costs of actions. 157 158 Externality External effects have been described as influences Of one actor upon another for which account is not taken in decision.processes. Buch- anan and Stubblebine have developed definitions for various classifica- tions of external effects which will serve to illuminate different kinds of interactions between railroad firms and members of local communities.1 Definitions of the various types of external effects will be used to develop criteria for private collective and.public action, and to take account of various special issues involving organization and transaction. MOdifications of the Buchanan-Stubblebine definitions are necessary to isolate only those dependencies between objective functions which are not accounted for and to consider the current distribution of income. Assume the existence of a local railroad line oWned and Operated by a railroad company for which.management's objective function is UR = UR'Cyk)' k = 1, . . . , n where yk is the flow of railroad service produced on railroad link k. Assume also a single, local consumer of railroad service with Objective function C U = UC (xi, yl) i = 1, . . . , HI where there are m.activities Xi for which the consumer holds both posi- tive value and the power Of decision to control the level of these ac- tivities, andy1 is the flow of railroad service on the particular link 1, serving the consuner's comImJnity. The consumer may be one of three 1JamesIM. Buchanan and William Craig Stubblebine, "Externality," Economica 29 (NOvember, 1962), 371—384. 159 persons. The consumer Objective flmction may be that of a direct user of railroad services such as a retailer or consumer of products deliv- ered by railroad, an employee of a firm with direct or indirect usage of railroad service, or a nostalgia buff who enjoys counting cars. Fin- ally, the consumer may be one who perceives no immediate use of the railroad but desires to maintain the Option to use railroad services in some future period, such as a prospective businessman. In fact, a sin- gle individual may represent all three of these persons simultaneously. Inclusion of the railroad activity ‘in both railroad and consumer value functions, establishes an interdependence between objective func- tions. TO the extent the railroad does not consider the value of rail- road service to consumers, this interdependency frepresents an external effect of railroad decision processes. Values expressed in the market I demand function for railroad service are internalized in the process of price determination. Even for low priced portions Of the demand func- tion which are not serviced, the fact that that portion of the demand function was recognized and deliberately not serviced, represents in- ternalization of the interdependence. A marginal external economy is realized by the consumer when (SUCH) 6Y1 with no visible means of market articulation of this value. Small changes in railroad service enhance the consumer's worldly position. A marginal external diseconomy exists when 509 ,0 6y1 160 and is ineffectively communicated to the railroad firm in terms of price. Incremental changes in service create a cost to the consumer. Non-marginal extemalities are those for which the consumer per- ceives no change in usefulness of small alterations in service, but major shifts in service do create an impression upon the consumer. A non-mar- ginal economy exists when C y 6U andJla—U-Ed >0 0 Gyl y1 for some given level of all activities Xi controllable by’ the consumer. In this form, the definite integral evaluated from zero to the current output level y1 implies the consumer gains nothing from minor changes in service level, but the consumer holds some positive value for the continued existence of railroad service. Other non-marginal external. economies may be evaluated between any two levels of service which are considerably distinct, such as the difference between daily and once per week service levels . A non-marginal external diseconomy appears when y C 92.: 0 and Jolg-g-l- dy1 <0 for a given level of all other consumer activities. While minor changes in service have no perceptible effect on the consumer, mere existence of the railroad creates a disutility for the consumer. For non-marginal dependencies to be truly external effects of railroad Operations, these effects must be poorly communicated to the railroad company via pricing signals. Development of further definitions of externalities requires the notion of equilibrium output levels for the railroad firm. Assume the 161 railroad has an exchange opportunity function ER=ER(yk) k=l,...,n whereby resources involved in link activity yk may be exchanged in the market place or bemeen links. TO maximize the railroadls objective function, UR, marginal rate Of substitution in production must equal marginal rate of substitution in exchange, for any activity yk. Thus, a private equilibrium level of railroad service 71 produced on link 1 will satisfy the condition 60R/6 yl GER/Gyl GEE/5),]. = agi/ayj where y j is the level of production or exchange for a numeraire link j. The marginal rate of substitution in exchange represents the opportuni- ty cost Of resource use in actually producing railroad service on a particular link. When the railroad company produces equilibrium service level, 71, a potentially relevant externality exists if the consumer desires some other level of service and railroad management does not know of this desire. Potentially relevant marginal economy and diseconomy exist when 80C 60C 93? - > 0 and 6371- — . <0 y1 = y1 y1 = y1 respectively. That is, given service level 371, if the marginal gain (loss) to the consumer Of incremental service units is positive, the 1 . i . a consumer may potentially seek to encourage the railroad company to in- crease (decrease) service levels. Objective fmction dependencies are 162 marginally irrelevant if the railroad's optimum service level is also the consumer's Optimum use level, that is, Y1=Y1 With all consumer activities fixed at levels xi, potentially rele- vant non-marginal economies exist where é-[fi =OandUCCf )>UC(§ —) Gyl _ 1’ y1 1’ y1 y1 = y1 for any y1 7‘ fl. Service level y1 may be greater or less than level >71. While incremental changes in service could not perceptibly please the consumer, the consumer might be willing to seek a significantly higher or lower level of service. Non-marginal changes in railroad'service level will be irrelevant when consumers are satisfied with service level 71, that is C 6‘9“ = 0 and UC(§i7 7'1): UCOTi. 71) 57'1 _ y1 = y1 for all yl 7‘ yl. Pareto relevant externalities are a subset of potentially relevant externalities. To be Pareto relevant, the effective marginal net gain to the consumer of an incremental service unit must exceed the marginal net loss .to the railroad producer for deviating from a private Optimal output level. Effective marginal consumer net gain is characterized first by sufficient resource endowment or resultant gain in marketable values 163 to compensate the railroad for Opportunity losses, and secondly, by con- sumer gain above Opportunity losses from foregone consumer activities. A.marginal Pareto relevant economy exists, then, where the consumer's marginal rate of substitution Of railroad service for some other activity Xj is greater than the company's net marginal rate Of substitution of service to link 1 for service to some other link j, that is, auc 801:5le yl > (-) G—L-It— jar-:5: ...Y1 = 771' When the consumer is willing and able to pay the incremental costs of added service units, where these payments are not communicated in the market place, a.marginal Pareto relevant economy exists. A marginal Pareto relevant diseconomy is defined as GUC w" as; C ) -—Tr-<-1FF- -E§:-h =Y1- When the consumer is willing and able to pay the company's Opportunity losses of unit reductions in service, a Pareto relevant marginal dis- economy exists. Buchanan and Stubblebine complete their definitions Of externali- ties with a less than satisfactory definition of nonrmarginal Pareto relevant economies and diseconomies. For discrete changes in activity level Ayl a definition for nonrmarginal Pareto relevant economies is stated in.a.manner similar to that for marginal economies, replacing 164 point slopes with ratios of arc SIOpes, AUC/ Ay1 ( ) AUR/ Ay1 ABR/ Ay1 009 ij AU /ij AEIE/Ayi _ ‘ y1 = 1 where my1 is equivalent on both sides of the definition. Arc slopes are sensitive to the range defined by A for any except linear functions. Permitting this definition to serve as a conceptual guide, a non- marginal Pareto relevant externality exists when the consumer's rate of substitution of rail service for some consumer activity exceeds the net rate of substitution of service to link 1 for service to some other link j. Translation of this conceptual definition to a measurement tool must be done with care . Pareto relevant externalities imply that with proper expression, the consumer could encourage the producer to adjust activity levels leaving the consumer better Off and the producer no worse off. Where the subject activity can be jointly consumed, a number of consumers can collectively express a joint value for activity adjustment, assuming costs of organization and transaction do not exceed net consumer gains after compensating the producer. Allowing P local persons to act collectively with organizational costs Co’ there exist marginal or nonmarginal Pareto relevant economies of railroad service level when 1P -1 P cuCp 80R 6BR Y y 71 El __1_ - c > (-) __l. - p‘ 450:2p 0 6U; 45%: j __ J .1. — y1=>’1 or 165 P AUCp/Ay1 AUR/Ayl AER/ Ayl z - C > (- - p=1 [SUE/ij ° ) 00‘9ij EE/Ay. y1 = y1 respectively . Pareto relevant externalities may exist in the presence of private producer equilibrium., Objective maximizing firms select activity levels 93 where added gains equal added losses for marginal output changes. For nonmarginal output changes, firms select activity levels where gains from a possible activity level are greater than or equal to Opportunity losses. 'With.numerous market alternatives for resource use, the finm 'will be constrained near to the equality of gains and Opportunity losses. Thus at private producer equilibrium the bracketed right hand.terms of preceding definitions equal zero. To the extent that the consumer group is willing and able to financially stimulate a deviation away from private producer equilibrium, a Pareto relevant externality still exists. Pareto equilibrium.may occur at a production level other than yi, say yf. Pareto equilibria for marginal and nonamarginal railroad output changes are defined by the previous definitiOns of marginal and non- marginal Pareto relevant economies , where inequalities are replaced by equalities and organization costs, Co, are zero. Where the sum of con- sumer gains equals the opportunity loss to the railroad from deviating from private equilibrium production, the consumer-group would be either unwilling or unable to compensate further production adjustments. When this definition is fulfilled at a.production level other than private equilibrium output level, yi, relevant externalities are abated. 'Conse- quently, the mere existence of external effects is not a sufficient 166 condition for private collective or public compensatory action. Where gains from internalization are less than concomitant losses, one party must lose which violates the Pareto criterion. Willingness and ability to pay for higher service levels or reten- tion Of service establishes an effective demand function depicting mar- ginal valuation Of serviceunits. A demand function for alleviation of external effects is not sufficiently well expressed in an active market to communicate with producers in terms of price signals. Willingness and ability to produce and offer extra-equilibrium service levels for compensation of marginal losses, establishes a supply function for the non-existent market. T‘urvey provides a geometric interpretation of Buchanan and Stubble- bine's definitions which permit representation of demand and supply furctions for internalization of values.2 In Figure 3, curve CC' is the aggregate consumer marginal valuation function for variou$ railroad ser- vice levels. Aggregation Of marginal values is achieved for jointly consumed services by vertical summation of individual demand relation- ships. Curve RR' represents the railroad company's marginal loss 8 function from incremental service levels. Marginal Pareto equilibrium exists at railroad service level y'fm. Output yi‘m is the competitive equilibrium output sufficient to'fulfill a normative goal of efficient resource allocation, where marginal con- sumer valuation equals marginal producer cost. If consumers could per- suade the government to force the railroad to operate at "desired" ser- vice levels, consumers would perceive zero cost and output OC' would be 2Ralph T‘urvey, "On Divergences Between Social Cost and Private Cost," Economica 30 (1963), 309-313. 167 I I I I I I I I I I I I I I I I I I I I I I I I I I I I I 1 0 y1m* C. y1 Figure 3. produced, at a loss to the railroad of ORR'C' and a net loss to society of C'EmR'. The railroad and, consequently, other shippers and communi- ties would, in effect, be subsidizing shippers and communities along link 1. This situation is analogous to that currently resulting from ICC rejection of abandonment applications. ~If the consumer was to compensate the railroad for marginal losses, the consumer would buy service level yim‘where marginal gain just equals marginal cost Of compensation. The consumer would.pay the railroad OREmyim dollars and receive a net gain of RCEm dollars. This situation is analogous to that expected to result from application of principles established in the Regional Rail Reorganization Act. The non-marginal Pareto "equilibrium" may be approached in slightly different terms, though the concept is the same. This will become ap- parent as criteria for internalization are develOped. Critical nonrmar- ginal decision.points are those of discontinuity. Where fixed costs associated with discontinuous levels of production.must be considered, Turvey's diagrammatic representation fails. 168 Private Collective and Public Investment Criteria NOrmative judgments expressed in the Regional Rail Reorganization Act of 1973 institutionally constrain public investment criteria to Pareto equilibria. States and local governments are granted authority only to act as bargaining agents for various railroad service consuming publics through: the price incentive system. Authority to permit and refuse abandonments is retained for federal jurisdiction. Non-federal governments cannot, thereby, force operations which worsen a railroad company's position. Rational public representation would limit trans- actions to those for which the public is not worse off. IMisjudgment of public demand could lead to public overinvestment or underinvestment in railroads. . The definition of Pareto equilibrium appropriate (for the abandonment prevention decision is the nonrmerginal one. Though railroad firms approach disinvestment of individual links with marginal tools, the issue of existence or“nonexistence is a nonrmarginal’one from the com- mtmity's view point. Each side of the definition equation will be de- veloped separately tO isolate each actor's values. Representation of each actor's valuations will be integrated to establish a Pareto equili- brium Which serves as the private collective and public investment cri- terion. Recall from Chapter III that market interactions of railroad com- panies and shippers will insure continued Operation of local service as long as discountedfuture net operating revenues are equal to or exceed liquidation value of the line, that is L 2 P. y. - P a 0 169 where Pik and yik are the discounted net price and quantity of transpor- tation, respectively, for commodity i shipped to and from link k and Py:k is the liquidation value for railroad link k of minimum possible capacity, Yo“ When the value of line liquidation rises above discounted future net earnings, the railroad company will be inclined to retrieve resources held in the line for reinvestment in other enterprises. How- ever, a lurp sum subsidy of magnitude U0, where _ L _ ”o‘PYOk Epikyik PLk'zpikyik>o Yo i would res tore financial incentive sufficiently to encourage continued local railroad service. An annual subsidy of _ L _ Ua ‘ 1’ (Pyok f Pik yik) L P Yok "Epikyik> 0 of indefinite commitment, where w is the railroad cOmpany's Opportunity cost of capital, would establish similarly sufficient incentive. The bracketed term in the non-marginal definition of Pareto equilibrium is equal to UO in present value terms or equal to De in terms of annual flows. For a P-member community residing along marginal railroad link 1, the aggregate consumer valuation for the line equals the sum of individ- ual consumer valuations P AUOp/Ayl )3 p=l AUEE/ij 170 screened through individual income constraints. Where there are R.possi- ble kinds of external effects, e r’ caused by.the existence of the local rail line for which each person holds a positive, negative or zero value, v the sum Of consumers' willingneSs and ability to pay for line re- 1p, tention equals PAUCp/Ay r=l,...,R X Ti: 2 Z V e _ 1 P p=1 AU /ij rp l‘p r p - , e e e , o Other consumption opportunities are accounted for by the ranking of projects in individual and governmental budgeting processes. The re- sult is a scalar expressing the community's total willingness and ability to subsidize the railroad for continued Operation. The social bound for resource allocation to service link 1, given normative institutional constraints, occurs where the sum Of payments fOr market and external values equals the liquidation value of the line, L 2 P. y. + z 2 v e = P . 1 1k 1k r P 1p 1‘ yok The left hand sum is the total social value of railroad service Obtain- able from the existence and service on.a marginal, minimum capacity line. If total societal value falls short of liquidation value, resources can be used.more efficiently elsewhere. From society's point Of view, this value requirement.mey'be biased downward since external effects of ac- tivities for which railroad resources could.be used elsewhere in the railroad system are not recorded in.the liquidation value. The social bound to efficient resource allocation to link 1 assumes costless organization and transaction for internalization of effects, that is, C0 = 0. When organizational frictions do exist, these costs 171 must be overcome in addition to compensation given directly to railroad producers. Thus the effective social bound.will appear at a resource allocation prescription lower than ideally suggested, L 2 P. y. + 2 2 v e - C = P . i 1k 1k r p rp r o yok .Market and external gains must be at least equal to liquidation value plus organization and trahsaction costs to effectively encourage line retention. ' 4 Organizational cost friction is particularly important when L PYk-<-’?Pik>’ik+”" o 1 r p rp er. 3 PYok 0 that is, where organizational cost effectively stifles investment. The fOrm of organization then becomes important in determining the level of organizational cost. Private collective action tends to be effective when.small numbers of individuals can identify their mutual interests and collect payments for subsidization at low cost. If a large enough portion of external values are internalized by this procedure, external economies are shed on those positively affected by existence of rail— road service but who are outside the private collective. If the required subsidy cannot be met with the willingness of a few to pay, a larger proportion Of the externality affected must be brought into the collective of consumers. As the group expands in size, costs of identification, communication, organization and collection rise. Identification of those externally affected is not a simple matter. Benefits to local businessmen and employees may be easily identified, though not easily measured. Benefits to those who wish only to keep the 172 railroad for potential future use as an alternative to trucking or as a means to receive very large assemblies if a plant is expanded, are not easily identifiable, even to those individuals harboring such values. Option demands are even more difficult to measure. A .Also as the grOUp required for minimum collection grows larger, eaCh individual feels less significant a contributor. The group could disintegrate if individuals developed an attitude of unimportance and withdrew from the group. These detractions to collections erode the sum of values collectible for Subsidy payment and detract from resource efficiency. When a small grOUp of private citizens are unwilling or unable to cover the required subsidy, government may be the least costly form of organization through which to express community desire to subsidize. Government is an existing institution charged with functions of collec- tive representation Of the public. Administrative, budgetary and en- forcement apparatus are established. The appropriate level of govern- ment to assume responsibility for railroad subsidization depends partly upon the bounds of significant influence of the subject line. When nearly all abandonment effects are incident Upon local communities, city councils or county commissions may articulate a large portion of nonrmarket demand. When.major effects cross county bOundaries, the state becomes the smallest unit of government appropriate to internalize the effects of abandonment. Establishment of new organizations to collect subsidy contributions is an alternative.“ However, the alternative may be an expensive one. New administrative, budgetary and enforcement apparatus must be estab- lished in addition to the duties Of subsidization and contracting for 173 service retention. An advantage of local railroad authorities is great- er local determination Of specific contract elements detenmining ser- vice levels. Authorities for individual lines could not, however, de- velop the expertise derived from many cases which an agent with broader jurisdiction.might gain. The Externality Account The technology of benefit—cost accounting provides useful concepts of external effect measurement and, to a.more limited extent, tools for this measurement. Given that direct market transactions reveal mar- ket values for service and that liquidation value reveals the Opportunity cost of maintaining line resources in service, an external benefit ac- counting procedure is applied to provide a.more complete basis for eval— uating cost effectiveness of the subsidy activity. Care must be taken to account only for changes in levels of external effects which differ in the community with and without the railroad line under investigation. In other terms, all external effects of abandonment which are measured must be caused solely by removal of the line. Willingness and ability of citizens to subsidize railroad retention to avoid losses not considered by railroad.management has been defined by 2 x v e r = l . . . R rp I-p r9 _ 8 9 p — l, . . . , P where vrp is the value held by citizen p for external effect r and er is the magnitude‘of external effect r in natural units. Individual values, Vrp’ may be either positive or negative and, in principle, for 174 any particular externality there may be a.mixture of positive and nega- tive values held by the P concerned citizens. The objective Of this section is to identify potential effects Of abandonment unlikely to be considered bylrailroad.management, and to propose measurable, nonrmonetary impact indicators which may accurately measure changes in level of magnitude of these effects with abandonment. Actual measurement is inhibited by the absence of technical data répre- sentative Of branch lines. Some empirical application Of impact indi- cators is introduced in Chapter VI. Discussion here is chiefly designed as a conceptual and empirical introduction to nonrmarket valuation of railroad lines. Individual valuation of external effects is not considered in this analysis. Values on nonrmarket effects are individually generated by wants and desires of individual citizens.’ Where governments plan to act as collective agents to invest in railroad branch line subsidies, complete multiple Objective benefit-cost analysis may be performed with ' close interaction with decision.makers. This fOrm.of analysis is high- ly perishable since the values of a particular group of political lead- ers are likely to be unique to the group. HOwever, a series of sudh studies may be useful in the future to assist development Of standard Operating procedures for branch line analysis, which lies beyond the scope of this research. Seven external effects of railroad abandonment are considered in the following paragraphs. TO properly judge the lasting effects of railroad line closure upon local, state and national communities, a .sufficiently broad time frame must be allowed to encompass human and organizational adjustments to the change of transportation services. 175 Breadth of geographic scope is similarly required to account for re- source adjustments outside the locally affected community, resulting from the abandonment. Employment Effects .A central policy Objective Of federal and state governments is main- tenance Of low unemployment rates. Employment effects Of railroad aban— donment are extremely illusive. Net number of jobs created or destroyed in the economy due to railroad line closure may be used to measure em- ployment effects. Care must be taken to view the economy broadly enough in geographic and temporal perspective to encompass intermediate run labor and capital adjustments. Care also must be taken to isolate jobs created or destroyed by line removal which would not be affected by the normal course of events with retention of the line. NUmber of jobs affected by abandonment depends Upon at least four major economic char- acteristics of the affected region, availability of transportation sub- stitutes, unemployment rates at various skill levels, mobility of labor and.mobility of capital. Where alternatives exist to direct railroad delivery with minor increases in transport cost, firms may continue Operating without rail- road service. Jobs are threatened only when firms are forced to close7 due to loss of railroad service. Transport alternatives are typically numerous. Trailer—on-flatcar and railroad shipment to nearby sidings with local truck assembly or delivery preserve the advantage of low cost, long-haul movement with some added cost of equipment and labor for transferral. 176 Ability to continue plant operations with increased freight ex- penses may be summarized in.Marshall's conditions for inelastic derived demand. Where the product of an affected firm.is essential but unim- portant relative to all other inputs into consuming industries and where there exist no good substitutes, the producer firm may pass on increased transport charges to customers. .A common barrier to the passing of costs is the presence of substitutes in the market. Identical products and services produced by other firms in the area act as near perfect substitutes in a competitive market. Where location adds little or no market advantage in an otherwise competitive industry, demand for the firmfs product may appear perfectly elastic, such that increased trans- port costs cannot be passed on in higher prices. These firms must bear the burden of abandonment from.profits. Where added transport costs cause profits to fall below those to other alternative uses of capital and.managerial talent, firms close and jobs are affected. Secondly, unemployment rates by skill category in the region in- fluence number of jobs affected by line abandonments. Where only fric- tional unemployment exits in all skill categories, layoff by one clos- ing firm.may likely cause only temporary unemployment while other firms bid for the labor services of the affected employees. Where structurall unemployment exists in skill categories prevalent in the closing finm, employee layoff may be prolonged for lack of similar local opportunities. Where general area unemployment exists with vacancies in skill categories prevalent in the closing firm, layoff may be again of short duration as employees are abSorbed locally. Third, geographic labor mobility affects the impact of line abandon- ment on jobs. Labor mobility is dependent Upon proximity to industrial 177 and commercial centers, existence of commuting facilities and cultural barriers to movement. Areas in the southern half of Michigan's Lower Peninsula are close to hundreds Of employing firms and institutions and well serviced by highway facilities. COmmuting to jobs in cities different from the city of residence is commonplace. Areas in Michigan's Upper Peninsula provide fewer nearby locations of employment. Change of employment location is more likely to require a family move than in the Lower Peninsula. Cultural barriers to mobility include racial and religious restrictions by geography and philosophy. Labor immobility tends to narrow opportunities for those affected by abandonment related layoff and intensifies the abandonment impact upon jobs. Finally, mobility of capital influences the net employment effect of the abandonment decision. Capital associated with local firms is released upon.plant closure. Some of this capital may move within the region to other industries, replacing old jobs with new jobs. Cap- ital may move within the industry to plant expansions or erection of new plants in locations with more stable transportation facilities; only job relocation is implied by such moves. Capital may move out of the region to create jobs elsewhere; this does not contribute to employment objectives in the affected region, but new jobs created offset job losses in national perspective. Finally, capital from departing indus- tries may be replaced by capital of industries entering the region to take advantage of vacated facilities and skilled workers. Local railroad abandonment.may create jobs by the implied substi- tution of labor for capital. Next least costly modes of transport such as trucking, local transshipment and trailer-on-flatcar use relatively more labor than direct railroad delivery. Where firms continue to 178 operate with transportation adjustments, employment in trucking and transfer may increase locally. Geographical distribution of job effects may affect the willingness of local collective agents to subsidize a railroad line. In national perspective, a job loss occurs only if number of jobs lost is not off- set by number of new jobs created. However, a local or state government tends to act to maximize the welfare of individuals within the boundar- ies of its jurisdiction. Jobs destroyed in a local community serve as an impetus to provide local subsidization of railroad links. This re- action is inefficient in the sense of resource allocation. The larger are the bounds of authority controlled by the acting collective agent, the less will be the incidence of this form.of inefficient reaction. The multitude of labor and capital adjustments makes measurement of abandonment-related job loss nearly impossible. NUmber of local jobs affected by line closure may be estimated by interviews with railroad users. Hewever, the measure of local jobs affected has no meaning in directing efficient resource allocation, unless applied under severely restrictive assumptions. These assumptions include perfect perish- ability of capital associated with plants along the line and.persistent unemployment in skill categories predominant in railroad using firms. Economic Rents to Fixed Facilities Land values and rents to physical assets, constructed under the presumption of continued existence of the railroad, may decline with loss of the railroad. A portion of this decline in values has already been accounted for in the magnitude of discounted transport cost increases. A portion also may have been taken into account by property owners 179 discounting for risk at the point of the initial investment decision and investment in insurance of various other forms. For firms planning to remain in the region, abandonment related rental losses are wholly accounted for in the discounted value of trans- port cost increases which cannot be shifted to consumers. The value of properties and structures is the discounted value of their streams of net returns. Since the only difference in net returns to properties with and without a railroad is access to railroad transportation, the additional cost of transportation substitutes is the only decline in net returns which can be isolated to the abandonment decision. For firms forced to leave the area for lack of railroad service, value to the firm of local properties has fallen below opportunity cost of salvage and possibly below the cost of plant reconstruction at another location. Property losses by firms attributable to the abandonment de- cision are equal to the discounted stream of marginal revenue product with the railroad, less salvage price without the railroad, less current value of various insurances against risk, less discounted future value of any comparative advantage gained in the move. Tax savings which the firm.may collect on the loss also enter individual firm decisions to subsidize, but do not reflect a net economic value. Gains from comparative advantage in movement are often overlooked. Comparative advantage often drifts away from established plants as time passes. Firms cannot respond immediately due to resource fixities. How- ever, any decline in value of current Operations makes the financial reward of relocation relatively more attractive and property losses at the original location are partly offset by an even higher level of rents available at the center of relative production and.marketing advantage. 180 Consumer Price Effects The objective of social demand estimation is to determine community willingness and ability to subsidize line retention, A.simple estimator of price effects is available. Where railroad service is discontinued and local business operations are continued unaltered, the added cost of next least costly transport would be borne by either producers, in- termediate consumers of products produced by railroad using firms or consumers of related final products. Incidence of added transport expenses depends upon elasticities of supply and demand at each market level. Where either industry supply is sensitive or demand insensitive to price, at least a portion of added transport eXpenses may be passed on to consumers. The more elastic is SUpply and the less elastic is demand, the greater is the proportion of added transport costs expected to be passed on to purchasers. Bulk fertilizer serves as a good example. Bulk fertilizer satis- fies at least two conditions for inelastic derived demand; fertilizer is essential and there are no close substitutes, either physically or geographically. Bagged fertilizer is far more expensive than bulk material, in large volumes. Bulk fertilizer distributors typiCally service areas of radius not exceeding ten.miles, due to the technology of application. Consequently, a large portion of cost increases may be shifted to farm purchasers. The magnitude of community willingness to pay to avoid abandonment related price effects equals the sum of added transport expenses, re- gardless of incidence. Where all incremental transport expenses are borne by direct railroad users, all price effects are incorporated in the market bound with consideration of potential revenue enhancement 181 by railroad price discrimination or collective user subsidy. In this situation there are no concomitant consumer price effects. Where a portion of increased transport costs is shifted to consumers, very large portions of the community bear interest in line retention. In both instances, total community willingness to subsidize to avoid.price effects of line closure is identical to added transport cost. In em- pirical applications, consumer price effects will be measured jointly with potential revenue enhancement by market mechanisms. Sufficient information to determine incidence of price effects is not available. Abandonment and Energy A useful nonmonetary indicator of stress put upon energy resources as a result of line closure is the change in gallons of fuel consumed without the railroad. This may be calculated by determining the differ— ence in gallons of fuel used.with and without the railroad. Gallons of fuel may be estimated by dividing tonemiles of transportation service performed by each.mode by the respective transportation-energy efficiency ratio. The ratio is typically reported in units of tonrmiles or passenger-miles of output per gallon of fuel input. Consequently, divi- sion of ton-miles by the efficiency ratio in ton-miles per gallon results in a measure of fuel in gallon units. Some estimates of the transportation-energy efficiency ratio have been made for alternative modes of passenger transport and crude, aver- age measures can be calculated for freight transportation. G055 and McGowan estimate that in 1972, the united States consumed nearly 15 x 182 15 10 BTU's of petroleum fuel.3 (One gallon of petroleum is equivalent to 1.3 x 105 BTU's.) Of this energy, 55 percent was consumed in trans- portation, in 1965, and 60 percent is projected to be consumed in trans- portation, by 1980. Linear interpolation suggests that 57.3 percent of petroleum energy was used for transportation in 1972. Of energy used in transportation, 3.5 percent is consumed by intercity railroads and 7.0 percent by intercity motor carriers. On the basis of these data, total petroleum energy consumed by intercity railroads and trucks is approxi- mately 2.31 and 4.63 billion gallons, respectively. The Task Force on Railroad Productivity reported 1972 freight trans- portation outputs by railroads and motor carriers at 785 and 470 billion ton-miles, respectively.l+ Thus, industry average transportation-energy efficiency ratios may be estimated roughly as 340 tonrmiles per gallon for intercity railroads and 102 tonrmiles per gallon for intercity trucks. comparing industry averages, railroad carriage is nearly three and one- third times as efficient as motor carriage, in terms of tonrmiles per gallon. When estimating transportation-energy efficiency ratios for passen- ger transport modes, G055 and MCGowan also found great variability in energy efficiency within modes under various operating conditions.5 Cbnsequently, comparison of industryewide averages of energy efficiency is a highly imprecise measure of energy effects of local branch line abandonments. Branch Operations entail assembly and distribution opera- tions with short trains and numerous stops and starts. Measures of 3W; P. 6055 and J. G. McGowan, "Transportation and Energy -- A Fu- ture Confrontation," Transportation, 5 (Summer, 1973), pp. 17-42. 1*Task Force on Railroad Productivity, Railroad Productivity, p. 3. 5G055 and McGowan, "Transportation and Energy," p. 32. 183 energy effects of line closure will remain imprecise until transporta- tion-energy efficiency ratios are determined for distinct railroad func- tions. Confidence in the fuel consumption estimator awaits description of its statistical properties. The value placed upon this nonemonetary measure of energy effects must reflect only the demand for fuel preservation over time. value of fuel in current use is already considered in fuel prices which com- pose a portion of operating costs of railroads and alternative trans- port modes. Environmental Impact Effects of rail line abandonment upon the environment may be viewed in both local and national dimensions. Three topics of environmental concern relate to air quality, noise levels and susceptibility of citi- zens to accident. To the extent that local traffic is shifted to trailer-on-flatcar or local transshipment modes, environmental effects of local line abandonment Upon exterior regions will be negligible. A shift to long-haul trucking, however, creates additional air, noise and accident effects upon communities along routes to distant origins or destinations. Values associated with environmental effects are to be converted to streams of annual expected net values and subjected to a discounting procedure to arrive at present value. Local environmental impacts with and without a railroad are un- certain. With a railroad and a given level of'motor vehicle traffic density, a local air pollution level is determined by gas and particu- late emissions from.manufacturing plants, waste disposal plants, motor vehicles and locomotives. ‘Without a railroad, locomotive emissions are 184 removed and increased truck emissions are added. When.manufacturing plants are forced to close due to railroad closure, these reductions in local emissions are to be accounted for. However, in broader geographic perspective, relocation of the firm will merely reintroduce similar industrial pollution elsewhere. Similar accounts of community noise levels may be considered. Abandonment replaces locomotive and train noise with increased noise from trucks. Noise levels have three important characteristics, sound pressure level, duration and location. Sound.pressure level, in decibel units, measures the intensity of sound. A train whistle, for example, heard at five hundred feet has a sound pressure level of ninety decibels.6 Sound intensity within a city bus and the maximum standard for back- ground noise in factories, established by the Department of Labor, are also of ninety decibels. The sound of a truck downgrade has been.mea- sured at over one hundred decibels. Though train whistles and truck down- grades are of short duration, Operating sounds are sustained for longer periods. Location of noise is important because of the additive nature of sound pressure. One element of noise in a rural area.may not be as harmful as one more element of noise in an already noisy urban area. Differences in susceptibility to accident in a community with and without a railroad are also ambiguous. The net change in accident pro- bability consequent with line closure equals increases in accident pro- bability resultant with abandonment related additional truck trips less the probability of car-train collisions at grade crossings on the line. 6Nancy W. Sheldon and Robert Brandwein, The Economic and Social Impact of Investments in Public Transit (Lexington,’Mass.: D1C. Heath and CO., 1973), p. 53} 185 . Probabilities, in units of accidents per ten.million vehicle miles, may be multiplied by average dollar valuation of damage in property loss and injury in highway and car-train accidents. Total value of damage in property and injury may be either positive or negative, depending upon the relative expected value of added highway accidents and reduced car-train collisions. - Environmental effects of closing lightly traveled branch lines are likely to be quite small.‘ Since railroad traffic is sparse to begin with, added trucking activity due to abandonment would also be slight. An illustration of the magnitude of traffic diversion to trucks is illustrated in the following section. Traffic Diversion and Highway Life I One effect of diverting railroad traffic to motor transport may be accelerated deterioration of highways. Accelerated deterioration would reduce highway life causing more intensive roadway repair and.more rapid , replacement. These are costs to taxpayers except for,the value of truck-l er user charges collected on net truck enterprise units entering the market to replace railroad service. ; Measurement of highway life effects of new traffic has been a topic of research by the Michigan Department of State Highways and Transpor- tation. The department's study is designed to determine surface thick- ness required to produce a standard service life under projected traffic patterns. The procedure requires several steps and.makes reference to tables and charts standardized to lower peninsula Michigan traffic 186 patterns.7 First, average traffic flow is estimated over desired ser- vice life. Secondly, commercial traffic volumes are segregated from' passenger automobile traffic. Third, all traffic flows by various vehicle types are converted to standard 18-kip single axle weight equivalents for measurement of traffic loading on the highway. The 18- kip single axle unit is not just a unit of weight. Rather the measure- ment is a standardized unit of vehicle "use” of the roadway resource, developed in road tests conducted over a two year period by the Associ- ation of American State Highway Officials. One 18-kip single axle unit is a standardized.amount of roadway damage done by passing a single axle of 18,000 pound load over the surface. This is equivalent, for example, to a two-axle tractor pulling a two-axle trailer and a three- axle tandem trailer. Engineers use these traffic demand.measures to determine thick- ness of pavement and quantities of reinforcing steel material to be em- bedded in the structure. The measurement may be converted as an econ- omic measuring tool to determine the degree of roadway life deteriora- tion implied by railroad abandonment. Traffic forecasting begins with an initial average daily traffic measure and is adjusted for expected growth trends. Recent average daily traffic figures are available for every roadway segment in.Michi-v gan, reported in sufficiency ratings.8 If a constant annual rate of 7Fred Copple, "Procedure for Design ofKContinuously Reinforced Con- crete Pavements," Michigan Department of State Highways Research Report No. R-609, Research Project 61F-64(l), October, 1966. 8Michigan Department of State Highways and Transportation, Michi an Highways: 1973 Sufficiency Ratings by District, Report No. 153, Inter- state and sufficiency Unit, Transportation Planning Division, Lansing, Michigan, 1974. ‘ 187 traffic growth is anticipated, of rate r, average daily traffic for the entire period is Tn’ where _ n_ _1_1 Tn - TO[(1 + r) 1][r + 24 and n is the expected life of the roadway. For approximations assume ‘n = 20 years. The A.A.S.H.O. estimate of average highway life nation- wide is slightly less than 20 years.9 The long term average daily traffic is divided by two to determine the flow in each direction. The percent of total traffic composed of commercial vehicles is recorded for each roadway segment in the highway department sufficiency ratings. For multiple lane highways, hourly volumes of commercial and passenger traffic moving in one direction are compared with Figure 4 to determine the prOportion of vehicles in the right lane at any moment. The right lane is most heavily traveled and is, thereby, the critical lane for decision making. The average daily number of vehicles moving in one direction in the right lane may be detenmined. Next, the total number of commercial vehicles in the right lane must be distributed among vehicle types to permit conversion to l8-kip single axle units. Table 21 provides distribution, 18-kip single axle conversion factors and total 18-kip single axle units per hundred.vehi- cles, for three general traffic densities. Vehicle type distribution in the table is based Upon.Michigan traffic counts during 1964 and 1965. Heavy traffic routes are those connecting interstate commercial centers. 9William W. Hay, An Introduction to Transportation Engineering (New York: John Wiley 8 Sons,’Inc., 1961), p. 391. PERCENT 3883838 8 188 COMME RCIAL VEHICLES IN PASSENGER Z 4 E 0 IO ‘ I2 I4 I0 I. ~20 22 24 20 26 30 32 TOTAL VOLUME IN ONE DIRECTION, HUNDREDS OF VEHICLES PEN NOUN Figure 4. Percent of Commercial vehicles and Passenger Cars Traveling in the Right Lane for Different Traffic velumes 34 36 189 . .82 3.2.38 ....-. .oz 8.8%.. 6.8.8.. .9633: 83m mo 2808.8 .835“! : 3.85.6.— ouohxso 63.353. 3.32.50 mo .5me ..om 3.6389. .0398 v9...— .858 8... . ..8. ...... ..8. .. .... ...... ......— .... 8... ... 8.. 8... ... .... 8... ... .3 o I I I .... .... ... I I I .-. ml . I I I .... .... ... I I I ... sum 8 .. .... . .. 8 .. a. .. . .. I I I .-. mun .. .. .... ... u. .. .... . .. .. .. 3 .. u .. .-. min 8.. ... ... .... ... ... 2... ... ... .-. «In I I I .... .... ... I I I ..-... NHL. I I I .... .... ... .... .... ... . ...... :1. I I I .... .... ... . .... .... .... ...... can. I I I a... .... ... .... .... ... ...... a... I. I I .. .. 2... . .. 8 .. .. .. . .. .. .... mi. «... 8.. ... . .... 8.. ... .... 8.. ... .-.... 7.. .... .... ... .... .... ... .... .... ... «.8. one 8 .. .. .. ... .... .... .. .. .. .. .. .. . .. .- ... n... I I . I I I I I I I ... man I I I I I I I I I ... 7n I I I I . I . .I I ..I I ...... .... 8... .... . .. 8... ... .... 8.. ... ... W . I I I I I I I I I S... cum I I I I I I I I I .... I I I I I I I I I ...... .... 8.. ... .... 8.. ... 5.. 8.. 8.. .5... .. .. .... . .. I I. I a. .. 2. .. 8 .. «.... .... 8.. ... .... .... ... ...... .... 8.. ...... .... .... ... .... .... ... 8... .... 8.. 8. 8.. o. .. ... ...... .. .. . .. u. .. .. .. o. .. .. ... mum .... .... .... 8.. .... ... .... .... .... a. ... .. .. .. .... .... .... . .. a. .. ...... 2. .. .. 8. .... .... ... .... .... ... .... 8.. 8.. ...... ...: .... ...... .... .... .... .... .... .... a. w «In .... 8.. ... I I I .... .... .... ... .... .... .... .... .... .... .... «... .... .8 nun .. .. a. .. . .. .... 2 .. . .. u. .. a. .. . .. . mum .... 8.. ... .... 8.. .... . .... 8.. .... a. «In .... ...... .... .... ...... ...... 8.. . ...... .... u 1 TN 3.928» .3023. .830 3.028. 8.92.5 .3032. :92... . 3.2.8.. 2.32; .2920.» ..:... .2030... 39.25.80 .3. 9.0.0...— .d.9..o.quU .80....550 ..8 83:... 3.895800 39.95800 ..3 9.39...— 3.9.2.350 8. ....x_ 9...: 223.33 S. .3.— .oz 8. ..on ...—.2 329:6“. 8. .3..— .oz 8. ...... 3...». 83.23?“ oo— uofi .oz 09:. @030 3...... ..:... ......o. .59... ......» ..:-.. .2-.. .3... 2...... .57.. .2-.. 3.... v.2...» huouauoauq can..." 7.9.9.330 5:0: .89.... 3825.80 53qu 2:8... 3.8.6580 ...“...— O eowusflfimg 3&3... QUEER. mo begsm Hm mama... 190 Medium commercial traffic roadways are those connecting industrial cities within Michigan, such as the interstate system. Finally, light commer- cial traffic highways compose the rest of Michigan's state and federal highways. Further studies done since 1966 have shown commercial vehicle type distribution to be quite consistent across locations, within heavy and.medium traffic density categories.10 ‘Variation of vehicle type dis- tribution is more pronounced in the light commercial traffic density group. Two sample studies were taken within the two-county study area which is the subject of empirical application in Chapter VI. These sample studies suggest that the distributions indicated in Table 21 are useful for estimation.purposes. Table 22 shows the results of traffic surveys at the Portland scales on Interstate 96 whiCh represents a.medium commercial traffic trunkline and at the Ionia scale on.Michigan.Highway 66 which represents a light commercial traffic highway. Truck type of Table 22 corresponds with laboratory codes in Table 21. Nete the simi- larity in percent distributions of average daily vehicle passages in Table 22 with the generalized distributions in Table 21. Individual truck type 18-kip single axle equivalents were found to have very little variance between location or density category. Conversion of passenger car traffic is much easier. An average automobile weighing 4,000 pounds has an equivalence of 0.0004 18-kip single axle units. Nhfltiply this conversion factor by the number of passenger vehicles moving one direction in the right lane eaCh day. 10Fred Copple, ”Statewide Determination of Highway Loadings and Conversion to 18—KIP Single Axle Load Equivalence," Final Report on a Highway Planning and Research Investigation Conducted jointly between the Federal Highway Administration and the Michigan Department of State Highways and Transportation, Research Report No. R-814, Lansing, Mfichi- gan, March, 1973. Dme rcnce (Avg. daily loss the 9 mm. to Average Vehicles. percent Ionia County m 66) TYPE Truck 191 on TWo Michigan Highways (Avg. dally less the DING n't'l'lC‘ ) "a 3011310001121001000.1000103 .......................... a 040w0 00000 000.00 0.000 0000.00 m 6 m 88303 130057621130012 000000 ......................... 0. ““25“ 30000 000.00 00020 000100 3 y m 10006 33006 36111 20011 000103 .......................... r “”25“ 30000 00000 00020 000100 12334 56705 67800 13343 673334 1 111 ...-n ...-n ....- ..o.- ...... 33233 33334 44444 44466 633006 vehicle Type Distribution and.Average Daily Volume 9 mm. to mft‘fl" Portland Scale (I 96. Average Vehicleo. Tyne TABLE 22. Truck ) w. 07322 60111 11011 30010 000101 .- LtmLaw L0.0.0.0. m0.0.0.0. 00.0.00 000000 .- .... . .. .. . . . h g u 6 24034 67000 57543 12063 011321 m &7.Lt.m L0.0.0.131000 10000 000100 0. ll. ...-2 II 3 v. m 3761617119 4653783053011322 ......................... 54130 4000.0 3100000000 000100 M 11 13 3 12334 56733 0709” Hdfl45 673234 go... ....- .uono ...-o ...... 22213 33334 44444 44456 654666 f Highway Loadings 10D 0 and Conversion to 18-kip Single Axle Load Equivalence,” t rmina Mfichigan.Department of State Highways and Transportation, Research Report No. R-814, MarCh, 1973. Fred COpple, "Statewide Dete Source 192 .After calculating total average daily 18-kip single axle units pass- ing over the highway during the next 20 years, impact of additional traf- fic upon highway life may be viewed.using Figure 5. Figure 5 shows the relationship between daily load in one lane and service life'for three surface thicknesses. First, compare current traffic volume with the figure to determine whether service life is yet being threatened. Secondly, add anticipated traffic diversions causediby railroad abandon- ment to initial average daily travel. Then repeat the procedure for calculating traffic load. The difference in expected service life of a roadway of given thickness may then be approximated from the figure. An example will help. To observe an unrealistically concentrated, traffic diversion to a single highway, suppose all Clinton County rail- road traffic was diverted to truck at a conversion rate of three truck- loads per railroad carload. Let all traffic move toward St. Johns and on to Lansing by way of U.S. Highway 27. What is this maximum effect of traffic diversion on service life of U.S. 27 between the two cities? .A total of 579 carloads were generated or terminated at Fowler, St. Johns and Ovid during 1973. JMultiplying times three converts carloads into 1937 truckloads annually or 4.76 vehicles added to average dailyitravel. Assume traffic will be distributed.among the large freight trucks in the proportion of medium commercial traffic density, or 0.81 18-kip equivalents per vehicle. Assume also three alternative annual traffic growth rates, three, six and.nine percent. Clinton County is an agricultural county for which a vast majority of originating and terminating shipments service the agricultural industry. Average annual growth in county grain 2500 soon 3500 I DAILY EQUWALCNT IO‘KIP SINGLE AXLE REPETITIONS m ON! LANE 1300 193 \ \ ‘Q IN. PAVCM IN. “VINCENT \ \ \ \\aseo sfiame Haney .mH mecca. x fimuvv mama pawns on mouse a.~ H.N o.H co mouxm ouwaam max-wu oaofim>aseo sfiaam .QH AfiNHV x fiHHVV emw.o omN.m omm.m oqafi nemfic no coaooooae some so mooo< .mH fie onsmaav mama oeMuo 55.0 mw.o mm.o an couoooofle come on mouse couoooaooa .NH Hom.w mom.o Hem.¢ nfioV - “moo :oaoooofle sumo an moo:<_ .HH Hm ounaa fiuq.em x have mama “swag ca mausoo a.mme m.cmm a.mON mo mouxa oumcum max-wfi peofim>asco sfluao .OH Ammo x have mama pawns an coapuooae com mac mme sumo an mouuaeo> Hmaooosaoo Hooch .m 9 game 05H Hm.o em.o om.o ucmfla ca moHofico> HmfiuaoEEou :ofiuHOQOHQ .w meN . fimvv Nae Now on coflpoohflv sumo a“ ossfio> Sauna: Hooch .n hfimv x “mug :oaouooae mam Hoe mom goes so mouoaeo> Hauoooescu edema .o omw.m cue.“ ovo.m mm . fleov coaouooua sumo Hn<. .m Hwa.mu muo.efi Hoo.cu ammo x mva memo» ON oo>o en< ommoo>< .e no.N mm.H om.u amassooav Hooumm epzoou oucmmoe .m 30H won sou Amwauoam soeouoammsmv HmaocosEoo ocoooma .N cow.“ cow.“ oov.a mmmcuomm sucoaoumwsmv em< HmuoaaH .H so so an _sooH comm npzoho .hmo» ommm mmmfi .moumm cpzohu oflwmmae onSmm< mosey omen: RN .m.: com each Unmoaoa osmooso meaomasufiao .mN mum00 00000 0000 0000000 00000 .5 000. x 0000 0000 00000 00 000000 00000>00 50.0 00.0 00.0 00 00000 000000 000-00 00000>0200 50000 .0 0000 x 0000 0000 00000 00.00 00.0 00.0 00 0000000> 0000000500 00000>00 00000 .0 20 0.5303 mama 00.0 00.0 00.0 00000 00 0000000> 0000005000 0000000000 .0 05.00 00.0 50.0 0000 x 0000 00005 00 0000 00000000 000. .0 50.0 00.0 00.0 000000000 000000 003000 0000000 .N 05.0 05.0 05.0 00000>00 00< .0 00 00 00 0000 00000 0003000 000» 000m 0500 .00000 003000 000000< 00000 0000: 50 .m.: 000 0000 0000000 00000 000 00000>0m 00000000000 .00 m0m<0 197 producers, community specific sampling may be undertaken by procedures outlined by C0pp1e. Option Demand Some persons not currently using railroad services may hold value in retaining the option to use such services at some future time. Since these Option demands are not expressed in a currently active market for service, these values are not taken into account by railroad Operators. Consequently, option values are external to railroad abandonment decision processes. weisbrod, the first to formalize the concept of option de- mand, suggested that option value arises from the infrequent or uncer— tain purchase of commodities and from the fact that reductions in supply may be functionally irreversible.13 Wéisbrod concludes that "if these consumers behave as 'economic men‘ they will be willing to pay some- thing for the option to consume the commodity in the future." Zeck- hauser adds another determinant of option value which is not related to uncertainty.1“ Consumers may place value in having a wide variety of goods to choose from, even though they may select only a narrow range of goods. Though this value does not appear in producers' profit ac- counts, the consumer may be willing to pay to maintain such variety, if a mechanism of payment is available. Option value, based upon both uncertain anticipation in actual use of services and desire for variety of service, is applicable to railroad branch lines. Once abandonment has occurred, renewal of service would, 13BurtonA. Weisbrod, "Collective Consumption Services of Individual Goods," Quarterly Journal of Economics 78 (August, 1964), 471-477. 1“Richard Zeckhauser, ”Resource Allocation with Probabilistic Indi- vidual Preferences," American Economic Review 59 (May, 1969), 546-552. 198 be possible only at the great cost of reestablishing roadway facilities. Two ready examples of option value in uncertain anticipation of actual future use of a branch line present themselves. One example is a busi- nessman harboring hopes for plant construction, expansion or modifica- tion for which the railroad would serve as the least cost means of trans- portation. Another example is a businessman who perceives existence of railroad service as a hedge against rapidly rising transportation costs, as truck rates rise relative to railroad rates in consequence to rapid fuel price increases. Indeed, the prospects of fuel becoming scarce is very real, making the latter rationale for option value an important consideration. At least two examples relate to the existence of rail roadway main- taining a variety of opportunities. One example is the view that exis-' tence of a variety of services maintains competition in the transporta- tion industry. Current users of motor carriage have expressed a de- sire for line retention to maintain reasonable truck rates. The argu- ment procedes that mere existence of the Option to use railroad.maink tains an upper limit on motor carrier rates. Another example is the view that existence of many branch lines provides a variety of locations for industry location. This, in turn, maintains a broad range of flexi- bility for future adjustment of population settlement.patterns. One argument is that pruning of the railroad system to mainline routes be- tween.major cities will compound.metropolitan concentration and inhibit decentralization. Weisbrod distinguishes two types of products produced by service units with a plant component, services in actual use and stand-by ser- vices to nonusers. Both Option value in anticipation and option value 199 value in competition derive from the stand-byfservices provided by mere existence of the branch line, with concomitant service schedules or ser- vice-on-demand rules. Stand-by services have characteristics of collec- tive-consumption goods, in that existence of the branch line provides security of future service at zero marginal cost to added nonusers. Though many individuals with an option value for the line will never use services, these individuals may be willing to pay up to the expected: value of future transport cost savings associated with use or competi- tive bidding. In collecting these payments, the cost to any individual of maintaining the line is spread among all who similarly value the line. Where probabilities can be assigned to future use or to monopolis- tic model pricing behavior, option value may be treated as a risk situa- tion rather than as an uncertainty. Collective payment then resembles the risk spreading mechanism of insurance schemes. Where the proba- bility of a particular individual to suffer highly valued catastrophe is small, a community may share the burden of risk by each paying up to their expected value of loss in catastrophe to provide for prevention. Similarly, for a community with a branch line, future railroad service may be insured by individuals paying up to their expected.present value, of transportation cost savings attributable to existence of the,1ine. EXpected.present value of transportation cost savings is composed of an array of possible transport cost savings and an associated set of probabilities of occurrence. The array of cost savings to the business- man eXpecting plant expansion is a set of present values of anticipated increases in shipment volune times the difference in railroad and next least costly transport rates, over the planning horizon. The array of 200 cost savings to those holding option value in competition is a set of ,present values of the anticipated difference in motor carrier rates with and without existence of the railroad line, times volume of shipments, over the planning horizon. Probabilities associated with each savings possibility will most likely be subjectively determined by each individual holding an option value for the branch line. Where true uncertainty exists individuals will be unable to determine the value of the railroad option, even though sOme value is present. The most effective mechanism for collecting payments representing option value depends upon the distribution of option values. If nearly all option values are held by a small group of businessmen, a group of railroad users may be expanded to include those railroad nonusers hold- ing an interest in.maintaining the line. VOluntary contribution or involuntary taxation within the group may then be designed to capture the value of option demand in a private user subsidy. To the extent such a mechanism.is effective, option value may provide one more expan- sion of the market bound. Where Option demands are held by a broader range of citizens, gov- ernment subsidy from tax revenues may provide a mechanism for expression of option demand. WOrkers threatened with layoff upon line closure may be willing to pay Up to the value of moving eXpenses required to take another job in another town. Local retailers may be willing to pay up to the expected value of lost profits expected with local economic re- cession. From a practical standpoint, the private railroad user and nonuser subsidy provides the easiest means to eXpress option demands. Actual measurement of value is not required. Individuals may apply subjective 201 probabilities to possible transport cost savings and contribute accord- ingly. The problem.with this method is that individuals may wait to see if their contributions are essential before expressing their full value. They may seek a "cheap" ride, if not a free ride. Taxation in the private group and by government requires explicit estimation of ex- pected values of future transportation cost savings and the level of priority to assign to satisfying these Option demands relative to the explicit demands and Option demands for other services. Summary The Regional Rail Reorganization Act of 1973 limits the jurisdic- tion of states and local governments to Pareto better adjustments for external effects of railroad abandonment. Jurisdiction is limited by requirements of actual compensation of railroads for retention of un- profitable roadway links. .Actua1 compensation shifts financial respon- ‘ sibility for unprofitable branch line operations from producers to con- sumers of external benefits of existing roadway links. In consequence, external benefits, once enjoyed by consumers at zero price, will be internalized on unprofitable lines and priced at the value of branch line deficit. Compensation of railroad deficit based upon external benefits accru- ing to the existence of a branch line raises two problems. First, ex- ternal effects caused by line abandonment have geographically wide spread incidence. Once long term adjustments are considered, losses to one community appear as gains to another. Subsidies representing effi- cient resource allocation will require external accounting by agencies with broad jurisdictional boundaries. State governments appear as 202 logical units for valuation, though some spill-overs across state boun- daries are highly likely. Secondly, long tenm valuation of external effects of line abandonment is a difficult procedure. One notable fea- ture of the impact indicators considered previously is their imprecision. valuation of these roughly measured impacts will require development of a set of standard operating procedures for valuation, by subsidizing authorities. .Market and social bounds to railroad service provision are now com- plete. Criteria for line subsidization have been derived from individ- ual firm and.market equilibria, based upon assumed individual firm.pro- fit maximizing behavior constrained by Pareto optimal exchange. These criteria are applied to a regional system of branch lines in the follow- ing chapter, to demonstrate procedures of branch line evaluation and to develop understanding of the magnitude of values involved in local rail- road branch lines. CHAPTER'VI APPLYING MARKET AND SOCIAL BOUND MEASUREMENTS: A.CASE STUDY One objective of this investigation is to develop readily useful measurement devices with which to aid railroad line investment decision making. Theoretical definitions of market and social bounds to rail- road service provision serve to guide data selection and investment analy- sis. Available data sources do not provide ideal measures of apprOpri- ate revenues, costs and social valuations. Despite the scarcity of ideal data bases, shippers and state agencies require tools of analysis which can be applied in less than thirty days time. ICC abandonment procedures allow the public thirty days, from date of filing, in which to protest removal of a line. For protests to reflect improved allo- cative efficiency of resources, results of analysis must be available prior to abandonment hearings. Consequently, this chapter is designed to demonstrate use of existing data sources and.previously developed estimators, supplemented only by interviews with affected shippers to determine actual freight shipments and receipts. This demonstration is designed to operationalize a.procedure which shipper groups and state agencies may follow to determine whether sub- sidization of a particular railroad line is justifiable. The procedure as demonstrated is limited to relatively small segments of line in MHchigan on which traffic flow is light. Application to major raierad system adjustments addressing broad questions of regional transportation 203 204 planning would require significant adjustments in assumptions and defini- tions. Recall from earlier discussion that the market bound to provision of railroad service exists where discounted future net revenues equal liquidation value of the line, i Pikyik = py:k° The rational region of regulated production exists where gains from main- taining the railroad activity are greater than or equal to the value of the liquidation opportunity. Recall also that the social bound to rail- road service provision exists where discounted future net revenue plus the sum of demands not articulated in the market place, less organiza- tion and transaction costs, equal liquidation value of the line, 2 P. y. + Z Z V i 1k 1k r p Society may enhance allocative efficiency of resource use by encouraging service continuation as long as the term on the left is greater than or equal to liquidation value. Measurement of each definitional element is attempted in this procedural demonstration, excepting organizational costs. .Arguments peripheral to economic measurement, but useful in complete abandonment analysis are included. .A two county region of Michigan was selected to provide a realistic demonstration of procedures. The area selected for this investigation harbors representative intermodal and intramodal interactions of service availability. This permits the realistic opportunity for traffic con- solidation from the lines of two railroad companies to the line of one 205 company. .Also observable are opportunities for one railroad.firm'to continue service to some customers at alternative stations. Clinton and Ionia counties were selected. Each railroad user was personally interviewed to ascertain volume of 1973 freight shipments and receipts. Questions regarding employment and likely reaction to a railroad closing were also asked. Information gathered in this inter- view process provided the line specific traffic and employment data re- quired for measurement. The procedure is developed in three steps. First, an economic base study is undertaken to establish likely trends in railroad traffic gen- erations and terminations. A regional transportation survey is also included in this first step to determine the viability of alternative means of transportation. Secondly, discounted net operating revenues and line liquidation value are estimated to determine the magnitude of subsidy necessary to encourage line retention. Estimates are made here under various types of assumptions to demonstrate application to various situations. Finally, nonmarket impacts of abandonment are identified and.measured where possible. Economic and Transportation Base Studies The economic base study includes surveys of resource endowments and trends of change which have implications on railroad traffic. POp- ulation characteristics of growth and.mobility influence both the mag- nitude of traffic movements and the area of influence attached to the particular railroad line. Distribution of business activity among sec- tors and activity levels determine the nature of railroad traffic. Trends of change in these elements are required for traffic forecasting. 206 The transportation base study entails a thorough review of highway, railway and waterway facilities available to the area. Productivity Resource Base Both Clinton and Ionia counties are primarily~agricultural with scattered.manufacturing establishments. POpulation growth is oriented toward the metropolitan center in Lansing. During the decade of the 1960's, the population of Clinton County~grew by 2.5 percent annually, above the statewide average growthrate.1 The 1970 population is re- corded at 48,492 persons. More than half of this growth took place in areas with.population aggregations of less than 2,500 inhabitants, there- by reinforcing the rural character of the county‘s population distribu- tion. The working population of Clinton County is quite mobile in that barely 35 percent of people working in the county reside there. Con- versely, great numbers of Clinton County residents work for automobile manufacturers and state government in Ingham County, to the south. Mo- bility between communities makes the distribution of employment and ‘multiplier effects of railroad abandonment unwieldy. Separation of work place and residence also increases the regional size appropriate for internalizing first round indirect effects of railroad investment decisions and increases organizational costs of private collective de- cision.making. The population of Ionia County grew at an average annual rate of only 0.6 percent during the last decade, below the statewide average. Population of 1970 is recorded at 45,848 persons. By~far the greatest 1All population estimates were taken directly from the U.S. Census of 1960 and 1970 or calculated therefrom. 207 population growth occurred in rural areas; the city of Ionia, the county seat, lost population at near1y~the rate at which the county was gaining inhabitants. Fastest growth was recorded in the southeastern corner of the county, the quarter closest to the metrOpolitan center of Lansing. Ionia county residents are less mobile than are those of Clinton county. Of those reporting place of work, nearly~70 percent worked in their county of residence. The industrial base of each county reflects a growing orientation toward the metropolitan center and a resulting stagnation of independent manufacturing activity. In Clinton county, the relative importance of manufacturing, wholesaling and transportation and.public utilities has declined slightly during the last decade, as shown in Table 25. The profile of business activity for the county is stable, except fOr major growth in construction activity. The low proportion of employment in manufacturing reflects the fact that 78.7 percent of the population is rural. Ionia County has experienced shifts of employment from industrial activities to consumer oriented activities, as shown in Table 25. The proportion of nonagricultural business employment in.manufacturing has fallen to nearly half of the total during the last decade; wholesale and transportation activities have stagnated. These industrial activi- ties have been somewhat supplanted by contract construction and retail activities. Absolute numbers of manufacturing establishments and.manu- facturing employment are below 1959 levels. Low and declining importance of industrial activity suggests a trend unfavorable for industrial traffic generations. Clinton and Ionia counties are becoming rural residential and farming areas with only ‘I 208 .mogSuowwsooz mo mzmooo .m.D "oOHSom 0.55 000.0 0.0 005 0.5 055 5.5 005 0.00 000.0 000.5 5500 0.00 005.0 0.5 000 5.0 005 0.0 005 5.00 505.0 000.0 0000 0.50 000.0 0.5 500 0.5 500 5.5 050 0.00 000.0 000.0 0000 00208 0.0200 5.05 005.0 0.50 000 0.0 050 0.5 000 0.00 000.0 000.0 5500 0.00 500.0 0.0 050 0.0 550 0.0 500 0.00 555.0 050.0 0000 0.05 005 5.0 00 0.0 000 0.00 505 0.00 000 000.5 0000 002000 2002000 .000 .02 .000 .02 .000 .02 .000 .02 .000 .02 .0000000000 002200 0000 020000000 200000000200 00000000: 000000 02000000002 02000000002<2H 00000 HUoa0m a: 00.005.0N - mm om.a - Na km.mm¢ + a Ha.0mo.fi ”02H0> 000>H0m 00000 HH0304 m0.mmm.mmmw oo.mnm.0mww 0°.eow.mw~w am.maa.0 a am.~um.mww ma.wmo.0mw N.¢H -00:0000 mo.aoa.mmow 50.050.0HHW mo.aom.0~um mm.mNm.m a- HH.0wm.omm mm.N00.oaw m.0 0fleoH H0.va.Namm aa.oua.0m a 0N.N0a.50 a 00.HNB.OHW- ao.amm.0ma mm.mNN.0H$ 0.a was: a0.afia.mfimw 00.000.05 a 00.0am.am » 0m.0am.fifiw- 00.Nom.amw NO.¢NH.mNm 0.m 050300 mm.aem.mmem m0.fiov.Nme m0.mvm.mmfim om.mam.0 m- om.uwa.a0w o~.¢am.0mw o.oa 00H30m ou.maa.awNw 5N.Hao.mmuw mm.wma.maum 00.0Ha.0 a- mm.amw.mmw N¢.omu.aaa H.m munch .0m mw.fiov.Nme m0.uov.NmHm m0.m0m.mmfiw ow.mam.0 a- om.awa.H0w ou.qaw.0mm o.oH 0H>o ..- u- ..: ..- nu u- u.. OmmOZO oSHm> oofim> pong umoo osam> ozam> :ofluooflsoflq mmoq osfim> ouoooopoflmz owo>amm pmou oww>Hmm mmoawzu coflumum o>fipmfioeso :ofiumoflzofiq mammowo>< uoz Hm>oeom mmOHo ouompmwm somflgoflzfl.fifiozoq 0p ommozo Scum c000003 ensue 0:000 ”003H0> acuumeflsefio 0:“; 00 :ofl00usufimu .0N mom0a00 00 00.000.0N - 00 00.0 - 00 00.000 + 0 00.000.H ”0:H0> 000>H00 00000 mm.~mu.0mmw 0H.mau.mfimw ooo.ommm 00.mmm.0mma mo.HmH.0Hw ww.m00.ooam 0m.nmm.0HHw a.mH mfiooH 00.000.0000 00.000.0000 000.00N0 00.000.0000 00.000.N0- 00.0NH.00 0 00.000.00 0 0.00 00000000 omooq -- -- -- -- -- -- -- -- 0:000 osH0> 03H0> oomq umou oofim>. osfim> ooflumwfloofiq 0004 03H0> MmmuHcmflw monocouoflmz ow0>H0m wwwmw om0>Hmm Mwmwgmw oofipmum o>flumfizeoo :ofiumowoofiq - u.H.n : m oanmofio>< uoz H m 00000 p .Q omwficoflz .mwooH on owooq 0:000 500w 00:0 0:0 oxmoowmocu “003H0> :ofiumofloofiq 0:04 we :oflumaooamo .uN mqm)t (24) Discounted present value of net (20) x (23) $100,888.37 operating revenues attributable to branch (traffic growth) (25) Discounted present value of net (20) f (21) $76,291.88 operating revenues attributable to branch (stationary traffic) *The example shipment type is outbound movement of twenty-five IOO-ton covered hopper cars of corn destined for Philadelphia, from St. Johns, Michigan. 222 Assignment of shipments to types of railroad equipment is possible with knowledge of commodity hauled. Origins and destinations are translated into railroad mileage using standard intercity~railroad.mileage tables. Mileage conversions must be accurate only~to the nearest fifty miles. Given distance, load weight and type of equipment, variable cost per hundredweight may be taken directly~fnom the ICC cost table for the official region excluding New England. Michigan is a part of this re- gion. Multiplication of unit cost by~actual load weight provides a car- load variable cost estimate. Multiplication of carload cost by number of cars involved in each type of shipment results in an estimate of total long run variable cost to the railroad system for operating this traffic. Commodity volumes intended for railroad movement but diverted to other modes for lack of railroad equipment should be added before total operating cost is calculated. Total railroad.systam revenue may~be determined for each type of shipment in one of two ways. One method is to collect actual railroad freight revenues from individual bills of lading during the shipper in- terview process. This task is often very difficult since many consign- ees return bills of lading to consignors or to accounting offices, re- taining no local record of freight bills paid. .A second.method is to provide a freight rate consultant with commodity, volume and origin- termination data and.purchase published freight rates for each.type of local shipment. Published rates multiplied times shipment volunes yield total revenues accruing to the railroad system from.particular types of shipments. The latter procedure was used in this demonstration. By either method, shipment volumes intended for railroad carriage but 223 diverted to other modes for lack of railroad equipment should be added before total revenue is calculated. The third task is to divide system costs and revenues between.par- ticipating carriers to isolate net revenues realized by the company owning the subject line. {A recent study cempleted for the Federal Railroad.Administration by R. L. Banks and.Associates, Inc., suggests a method of revenue separation treating branch.lines as "isolated operat— ing entities."7 Complete isolation is appropriate for feasibility analy- sis of the short line alternative, but not for the subsidization alter- native. Branch lines are parts of larger company systems. Continuation of service will cause company revenue gains of half the origination— termination charge and a.portion of remaining revenues proportional to the company's share of line haul distance. Thus, revenue is deter— mined not only by on-branch.operation, but also by~the amount of service performed by other portions of the company's system. Costs are incurred similarly. Terminal costs are accrued on the subject branch along with some line-haul service expense. Costs are also incurred in off-branch line-haul service. Both onrbranch and off-branch.revenues and costs are attributable to the branch, for these revenues and costs are caused by shipments originating and terminating on the branch. Discontinuance of service would result in removal of all company revenues and costs associated with shipments to and from the branch. A simple cost and revenue division factor may~be applied for cal— culation of costs and revenues attributable to the subject line. For 7R. L. Banks and Associates, Inc., Development and Evaluation of an Economic Abstraction of Ligh;Density‘RaiI’Line'OperatiOns,.A Report Prepared for’the Federal Rai roadedministration, Report No. FRArOE-73— 3, Washington, D.C., June, 1973, pp. 22-24. 224 each type of shipment, origination and termination charges, found in Table 2 of the ICC cost scales, are subtracted from total carload costs. This difference is multiplied by~the ratio of miles traveled on company lines to total length of haul. One half of origination and termination charges are added back in where two or more carriers participate in the haul. The formula for determining company share of carload cost ap- pears as a[VC - OTC] + 1/2 OTC where "a" is the ratio of company miles to total length of haul, VC is system carload variable cost and OTC is system origination and tere mination cost. If one company completes the entire haul, the full ori- gination and termination cost is included. This procedure provides a 1970 carload cost estimate attributable to the branCh. .A cost and reve- nue division factor is formed equal to the proportion of total railroad system cost which is attributable to the line under investigation. .An example appears on line 15 of Table 28. Freight rates obtained from the rate consultant were established for May 1, 1974. Thus, variable cost estimates must be converted from 1970 estimates to 1974 estimates for comparison. Nearly-half of vari- able Operating expenses is composed of labor expenditures. Estimates of 1974 variable carload costs are derived by inflating 1970 variable car- load costs by the rate of change in average compensation.per hour of railroad employees, over the period 1961—1971. Railroad wages have been accelerating. Percent change in railroad wages, w, as a function of tmw,t,is 225 0‘: 0.7618 + 0.8615t (0.2845) (0.0345) where t = 1 in 1961.8 Wage growth.factors for years 1971, 1972, and 1973 are 9.38, 10.23 and 11.10 percent, respectively. Costs attributa- ble to the line in 1970 are compounded over these three years to provide an estimate of attributable costs at the beginning of 1974. (The com- pounding factor is 1.0938 x 1.1023 x 1.1110 = 1.3395). Operating revenue attributable to a branch line from a particular type of shipment is estimated by multiplying total railroad system reve- nue by the revenue division factor. The realistic assumption made is that ICC rate division.procedures are designed to distribute revenues similar to cost distribution. The difference between 1974 revenue and cost estimates is the net annual revenue available to the company, attri- butable to the subject line. The final step in determining discounted net present value of con— tinuing line operations entails traffic forecasting and estimation of implied net revenues. The complete traffic forecasting procedure out- lined in Chapter IV may be abbreviated.when basic traffic data are collected by interviews with local railroad users. Mbdal split, dir- ectional distribution of shipments and route selection are revealed in observable behavior. Traffic forecasting collapses to estimating growth of traffic originations and terminations on the basis of an economic base study. 8This estimator is derived from data contained in Interstate Com— merce Commission, Bureau of.Accounts, Transport Economics, December, 1972, p. 1, Average Compensation Per Hour’IAll Time Paidfifor) Class I Line-Haul Railroads, Years 1961-71. 226 Two traffic growth situations are assumed. The first assumes a stationary traffic pattern over an indefinite period. A continuous traf- fic stream is presumed in the image of the 1973 traffic pattern. The second traffic pattern reflects long term.population and commercial growth trends discovered in the economic base study. .A twenty year in- vestment horizon is assumed for this situation. Outbound grain shipments and receipts of fertilizer and farm machinery are assumed to grow at the same rate as grain production in eadh county; six percent in Clinton County and three percent in Ionia County. Inbound feed shipments are assumed to decline by one percent annually in Clinton County and to re- main stationary in Ionia County, reflecting changes in cattle production. Manufacturing traffic is assumed to continue unchanged. Lumber receipts are assumed to increase at the rate of county~popu1ation growth, 2.5 percent annually in Clinton County and 0.6 percent per year in Ionia County. Analysis may be simplified by developing a "discounted growth factor" which reflects both the rate of traffic growth.and the Opportunity cost of capital. For traffic growth rate g and opportunity cost of capital r over a time horizon of T years, the discounted growth factor becomes T F=z 1” t. t=l (1 + r) t Net revenue in any base year multiplied by~this discounted growth factor is equivalent to the present value of net revenue which.grows at rate g for T years, discounted at rate r. Assuming a twenty year investment horizon, discounted growth factors for the various commodity grOUps are shown in Table 29. 227 Net revenue attributable to a line with a stationary~future traffic pattern.may be calculated by simply~dividing base year net revenue at« tributable by the Opportunity cost of capital. The present value of an indefinite stream of constant net revenues, discounted at rate r, is simply the annual value divided by the discount rate. Net revenue attributable to a line with consideration of traffic growth trends may be estimated by multiplying base year net revenues attributable by the discounted growth factor. Total net revenue over all types of shipments is obtained by summing the present values of net revenue obtained from each type of shipment. TABLE 29. Discounted Growth Factors for Future Traffic Generations in Clinton and IoniaCounties, Michigan“ Clinton Ionia Commodity g r F .g .r .F Grain Fertilizer 0.06 0.08 16.533 0.03 0.08 12.615 Machinery Feed -0.01 0.08 9.070 0.00 0.08 9.817 Manufacturers 0.00 0.08 9.817 0.00 0.08 9.817 Lumber 0.025 0.08 12.081 0.006 0.08 10.307 *A 20-year investment horizon is assumed. g = revenue growth rate; r = interest rate; F = Discounted growth factor 228 Discounted net Operating revenues for marginal links and cumula- tions, for the two example lines, are shown in columns two and four, respectively, of Tables 30 and 31. Estimates in the Upper and lower panels reflect stationary and growing traffic trend assumptions, respec- tively, based upon actual 1973 traffic. Columns three and five of these tables provide estimates of net financial surplus or deficit from con- tinued Operation of lines,'under the two assumed future traffic patterns. Net market values of continued operation of the Grand Trunk western line, shown in Table 30, are particularly illustrative of critical branch lines. Net market value reflects the difference between capital- ized value of net operating revenues and the Opportunity value of en- cumbered resources (liquidation values are presented in Tables 26 and 27). A positive market value suggests revenue surpluses above capital costs. .A negative value represents the magnitude of subsidy necessary to encourage continued operation. For the stationary traffic trend, the present value of future net Operating income from Ovid to St. Johns is $634,633. This value of income exceeds liquidation value by $499,592. One may say that the station at St. Johns generates sufficient traffic to make continued Operation of the St. Johns station profitable. But, the entire line to the St. Johns station.must also be profitable to justify continued, operation. The present value of net Operating income on the entire line from the mainline at Owosso to St. Johns is $1,042,981. 'This value exceeds what the railroad could make or save by removing the line by $838,760. Since both the St. Johns station is profitable by itself and the entire line leading to St. Johns from the mainline is- 229 .msoam uflmmmhu mama ngom GO @033 Ohm EOHHNHSUHmuum mm.aaa.mmo.aw Hm.mom.eom.am ma.oem.emw a am.mma.mmm m wa.mao.eam a mo.mNm.eam a om.aem.Nae a mN.mma.m~o.~a mm.aom.omm.aa om.~aa.ooe.aw ea.wom.mmm.fia Ha.mmw.mam.ua ma.omm.Nom.Hm ma.mem.eNo a oa.ama.soma- om.oam.oaea mm.oee.m a- Hm.ON~.em a- Hm.HHm.ooaw- ma.mwm.momm om.aem.maea em.ama.um a mo.mma.omma NN.¢©N.Hm a me.meo.ae % Nm.ome.am a oo.mNe.amow aa.mem.emoa Am.euv Haozoa -umcmamm Am.mv sfleoH flo.sv was: 3.3 053$ no.9HV amazes aH.mU wages .sm Ao.oav ease “schema use»-ONV ensue epzoso ufiwwwhp oa.ooo.mam a ow.eea.m5H.Hm o~.0Nm was a ma.eem.uoe a am.eem.oma a mm.ooa.wmm a a ON.HNm.eNm.Hm oa.msm.4ma.aw ON.aNm.me.Ha oo.amfl.ema.am om.aow.~mo.ua ow.owm.~eo.am oa.eoa.oafia- mo.wmw.waew me.wam.m a- mH.ooo.em a- ma.mam.~caw- oe.aam.mae» om.mae.oa a om.oam.mmmw mN.Nmm.Hm a ma.mem.ae a mm.oww.me a Aw.mmo.emem mm.eav Hamzoa -Omcmamm Am.mv mecca no.4v use; nw.mv osmzma mo.ouu Hafizoa flfi.mv mance .om on.moa.mmm Ne.oam.ame a ma.wou.mmmw No.0am.flaea “0.0HV euso neofiaom ouflcflmowch noose ufiwwmah th:o«umpm mpfloflmoov monso>om_ nuHOHmomv mosco>om amOHfizu msfioasm mafia uoz mafia moamanm mafia uoz mafia cOMprw $33250 $33356 35332 353mm: «campmoz Moose mango m :o mufloflwom pow momSHmhsm .mosco>om wcfiumammo uoz poucsoomfim ”mafia cochfiflmm .om mqmom fluflufiwoav mosco>om mmoaflso msfimhsm OCH; uoz ocflq msfimhnw mafia “oz mafia coflpmum o>flumazesu o>fipmasesu Hmcflwsoz Homemamz «ofiao pom owaQMmonu ”mafia pOOHHHmm m :0 mpfluflmom was momoamasm .mosco>om wcfipmaomo “oz emp:OOOmHo .Hm mqmo o>fipmasesu mafia Hangman: o>flpmaneso onus aquamamz passe nuzoao ufimmmah scope cummmse asseofluscm Ammauyc doflumum «modem noomsm mameoxm 03% co peoEoquncm ozco>om Hmfiucouom ESEwaz .Nm mqm poxamzflflmflucopom Ozam> poxamz Hmfiuoopom aoflmuo>flm ofimwwsh. cowmho>flm oammmsh :ofimao>fim Oflmwmah :Oflmpo>fim uawwmae cognac Opposes ofiwwwae thcofiumum Hmfiuaouom oe.aoe.NAN.Hm oe.eam.mmmm oo.smo.e0N.Hm oo.emH.AmNa cacaouaseam ozeo>om OHflZ Hmm aa.oum.~ a ea.mms.m a mm.oam.m a mm.amm.m a osuo> ocean: “oz osam> oe.oem.eNaa am.NNo.aoua ow.mmN.oeHa NH.NNB.H~HW omens: omz ozco>om ao.awm.ooaa mm.moa.osaa wm.oem.amaa ma.~om.moaa manomooao 802 ES mansions. . mm.osm.asom mm.oam.ueoa wm.osm.aeea mm.oam.asoa osao>.:oHomeaseaa poaowfimcoo uoz pogopflmcou poaopflmoou uoz posovflmcou Amosam> ucomommv cofiuofiaomon cowesuuz .Haozog Op mecca .um scam :uoymoz Moose posse coaumsfim>m poxamz do coaumpfifiomcou pom coflmuo>flm oammmhh mo mpuomwm ”mafia nonmam m mo .mm mqm aqua o>uuaaassu . 3.3 :33 em.mm~ NH»- oo.~ma.maaa- om.~am.- « ma.oam.maa- oa.¢oa.omaw- om.mae.oe ” oo.mam.oMNa -usesssm mm.aoe.amu mo.wmw.waea oo.o a mn.amo.ama mo.mmm.mas» om.oam.mmmm a¢.mam.maaa Am.mv mucoH m~.amm.~a» Hm.Hwo.em » oo.ooo.oo » mH.OmH.H ». me.mam.m a- mm.~mm.am “ sa.oaa.om a mo.sv can: mm.aea.a » HH.mms.He a on.mmo.oa a mm.mom.m a- ma.ooo.qm a- ma.mON.He ” «m.oom.ma a am.mc oeszma mo.a-.v a- m~.aa~.~v ». om.mam.ma » Hm.moa.~Ha- mo.mmo.a~fla- ma.mom.~m » mm.aoe.~mau flo.OflU amazom coaussas> seas assumes: 0.2.2 Rom 33> ucgugfifl 03: 33> 3:262 33> 653 3035 33> ”.923: $st2 onco>om pom 33> 93.32 33230 33 os3> cow m Houuaoooa Hoaueouoa Haaoeouoa ocean: poz ooz umz genomeaseua .p um .8:st comes; boeoflfiw ”among .3033 8 2:8. .3 58a mafia assume: Masha cameo oaflznm.mv 3 mo soapmsam>m nexus: rem mwumgmw 246 are unlikely to warrant market provision of service to these two stations, as tenminal links. Calculation of the market bound to provision of railroad service for each link and cumulations, provides decision.makers the opportunity to view alternatives of partial abandonment. Assume, for example, that the shippers of Muir are analyzing the viability of terminating the Grand.Trunk western line at Muir instead of at St. Johns. First, the marginal link to Muir must be viable as a distinct entity, after consid- ering traffic diversions and consolidations. Projected current operat- ing revenues fall short of covering liquidation.value by $1,156 per mile, but local shippers are willing to pay up to $60,000 in rate hikes or subsidies to maintain service, as seen in the upper panel of Table 34, column five. Potential market value is $11,887 per mile. Secondly, the entire 20.4 mile segment from St. Johns to Muir must be viable. The lower panel of Table 34 shows that for the entire 20.4 mile line segment, net.market value from Operations is a loss of $7,893 per mile. Collective willingness of all shippers of Fowler, Pewamo and .Muir to pay subsidy to the railroad amounts to $215,000, pushing po- tential market value to $2,640 per mile. Since the rest of the inter- vening line is relatively less profitable than the segment to MUir, market value to Muir shippers is diluted.over the entire length of the line. The maximum market value of $2,640 per mile is unlikely to cover land,value. The operating deficit to MUir station of $161,000 may be put in per- spective with traffic flows. This deficit may be alleviated with a constant annual addition to traffic originations of 50 carloads of grain, a fifty percent increase in grain.movements on the line relative to 1973 2'47 shipments. The deficit may also be alleviated with a constant annual addition to terminations of 85 carloads of fertilizer, more than a fifty percent increase relative to 1973 shipments. Effects upon shippers may be seen in the willingness of railroad users to subsidize the line or accept higher freight rates. In Table 34, colunn six records the sun of present values of increased freight costs to shippers by station and cumulations along the line. Like the values in Table 32, these measures of currently uncounted.market value are maximum estimates assuming continued shipment of all commodities except coal, and assuming no shipper discounting for service quality differentials. Finally, financial value of the Grand Trunk western abandonment to the Chesapeake and Ohio railroad system can be estimated by calculat- ing net revenue attributable to the line from traffic diverted from Pewamo and Muir and consolidated at Ionia. The Chesapeake and.0hio is a.much larger system.than the Grand Trunk western. Consequently, lar- ger prOportions of total system net revenues will be attributable to the local line than were previously attributed to Grand Trunk western lines for similar shipments. following procedures applied earlier, present value of net operating revenues attributable to the Chesapeake and Ohio line from added traffic are $2.22 million and $2.39 million assuming stationary and growing traffic trends, respectively. Where no insti- tutional constraints prohibit, the Chesapeake and.0hio Railroad could afford a countervailing payment to the Grand Trunk western Railroad of more than two million dollars to encourage abandonment. This offer ‘would be nearly ten times as great as the offer all users on the line could.make to retain service. Thus, barring institutional constraints, 248 the Chessie system could.pay the Grand Trunk western their market value of $317,826 owhich would be lower after considering land value and tax savings), and compensate local users for their increased transport costs of $214,872, and still enhance net revenues for the Chessie System in excess of $1.5 million. .Alternative to abandoning the Grand Trunk western line, is abandonment of the Chesapeake and Ohio line from.Portland to Ionia. A11 railroad traffic served.by the Chessie System.at Ionia would be shifted to the Grand Trunk western line leaving no current shippers without rail service. Consequently, no shipper would be willing to pay higher freight rates or provide subsidies to retain the line segment. The Chesapeake and Ohio could.make or save $518,715 by abandoning the line, with the forfeiture of $3,611,576 in discounted future net revenues, for a net company loss of over three million dollars, assuming the stationary traffic trend. Gains from land sale and tax savings on this 15.8 mile Tine segment would have to be nearly $190,000 per mile before the rail- road would consider abandonment. Estimating Non-market Effects The externality account developed in Chapter V suggests some dif- ficulty in accurately measuring effects of abandonment, outside the mar- ket bound. Effects of line closure upon consumer prices have been con- sidered jointly with private collective user sUbsidies and potential revenue enhancement through market processes. IMeasurement of abandon- ment effects upon rental values of land and facilities, upon the envir- onment and upon consumers of options is not attempted. However, empiri- cal measurement tools for effects upon jobs and fuel consumption are 249 introduced with the intent of demonstrating their use. Each tool is designed to measure the magnitude of effects in natural units. Valua- tion is not prescribed. Employment Effects Local job loss was suggested as an imperfect measure of immediate employment effects of line closure, in Chapter V. This measure assumes no capacity of the local economy to absorb laborers, perfect perisha- bility of capital associated with closing finms and is limited to a very narrow geographical perspective. In short, this indicator of job ef- fects serves only to reveal number of individuals temporarily affected by line closure and has no usefulness in directing efficient resource allocation. The technique may be applied to the Clinton-Ionia County area for illustration, however. Interviews with railroad users revealed that agricultural supply retailers would continue operations with railroad closure. The sensi- tivity of manufacturing firms to line closure is much more keen. Firms in the two county area which are likely to close without a railroad pro- vide examples of the determinants of employment effects. Branch plants of national corporations are most sensitive to pre- sence of railroad facilities. Managers at plants of national firms in St. Johns, Ionia and Portland suggested that alternative transport costs would be sufficiently great that rail line closure would precipitate relocation. Capital in plants of national firms is highly mobile. Jobs lost from closure of local plants are likely to be restored upon relo- cation of similar plants at other locations. Employment effects of this 250 nature are negligible to the entire economy, even though local individ- uals may suffer unemployment. The loss to the local employee is the gain to an unemployed worker elsewhere. One of the branch plants in the study region serves one function in the automobile assembly process. This and other facilities contri- buting to the process have been designed to handle special railroad equipment. Loss of railroad service would break the continuous flow of product in the long-distance assembly line. Maintenance of plant operations of the local facility without the railroad.would require investments to modify production processes in all contributing plants. In another branch plant, the central input to.production is a bulk material not currently handled by trucks. .Alternative transport would require bagging the bulk material before shipment and unbagging the material before use, at tremendous cost. In addition, the center of comparative advantage, as perceived by the firm, has moved eastward within the state. Line abandonment would cause relocation at another Michigan site. Eventually, even without line closure, the plant would likely move. Abandonment would merely accelerate relocation. Local jobs affected by firm closings are summarized by station in Table 35. Total number of jobs susceptible to line closure on the Grand Trunk western line in Clinton County is 701, all of which are in St. Johns. In Ionia County, only two jobs are similarly vulnerable, at IMuir, excluding potential employment effects in Ionia. Since Ionia has two railroads, abandonment of one line will not prohibit access to rail- road service by firms currently using the line to be removed. Forty- seven jobs are susceptible to line closure on the Chesapeake and Ohio line, in Portland. 251 .meHHHmH mchHmEop on“ >nvpoofi>hom on_wH:oz.wo:op:mnm on ou oGHH ecu xn po>pom >Hucm~hso mEHHm HHm wcflesmmm .mficoH Mom powaoooh uo: ma mmoH ooh Hmfiuqopomg o o osmzom mouw>hom ..o «o 28H N H HSBHBEMHH S H 328683.: .85 @5383 o o .838 o o «mem a N 33.53 Hang ngo w oxwomwmonu Nno N maHhsuumwscmz o o 8:28 922. .pm .0 «o «22 o o 35 VH5; Hams :55. 98.8 2555 25$ .5365 2356 25$ 3335 pouuoww<_ mo :oHpmuoq popuowm<. mo :oHpmooq Bow .8352 383mm 32. 83:52 32:33 moflpesou mflcoH pew :ouGHHu :H mucoecopcmn< mch wmopHHmm Scam MGHHHSmom mmoq now Hmooq opmfipoEEH .mm mqm