Posted by on October 1, 2020 1:07 pm
Categories: Competition & Regulation

By Mario H. Lopez, President, Hispanic Leadership Fund


A high-stakes debate on revenues generated by the freight rail companies threatens the decades of financial success enjoyed by industry after Congress passed deregulatory measures in the 1980s.


The debate centers around “revenue adequacy.”  Simply put, revenue adequacy is when the return on investment equals or exceeds the industry’s cost of capital.


Proposed changes to this metric could lead a implementing a revenue ceiling, which would harm the performance of freight rail companies and ultimately the price of consumer goods.


Despite often being overlooked in the public eye, freight rail continues to be a critical element of the American economy. The $80-billion industry supports more than one million jobs nationwide and generates billions in federal, state, and local tax revenue.


Consumers and producers across the board, depend on freight rail as a reliable, cost-effective way to move goods, while investors look favorably on the industry to maximize returns. As a result, America’s 140,000-mile rail network is arguably the best in the world with top-of-the-line infrastructure allowing it to accommodate ever-growing demand.


The Surface Transportation Board is the federal regulatory body responsible for overseeing American railroads. This roughly 40-year-old Congressional mandate is meant to serve two main purposes. First, to ensure that railroads are financially able to move goods and commodities effectively and efficiently throughout the country. Second, to ensure that markets are not being abused or manipulated at the expense of shippers. Most of the STB’s main regulatory actions revolve around revenue adequacy,


A quick look at today’s railroad marketplace shows the railroad industry’s financial strength and performance has improved over the years alongside gains in efficiency and investments in infrastructure. Thanks to a strong competitive marketplace, those improved returns haven’t come at the expense of shippers. In fact, the price of shipping goods has remained almost unchanged for well over thirty years.


Despite these strengths, at the request of some rail shippers seeking shipping rate caps, the STB is reviewing a change that would use the railroads’ relative financial strength as a means of capping rates charged by individual companies. Because the sector collectively earns returns above their cost of capital, they would be determined to be beyond revenue adequate under this model.


A new study by two University of Chicago Economics professors shows the serious problems with this approach. Professors Kevin Murphy and Mark Zmijewski show that incorrect or incomplete assumptions about railroad revenue adequacy threaten to make it more difficult for American freight rail to continue to operate, invest, and expand to meet future demand.


The deficiencies of using a static metric like annual revenue as a means of projecting long-term financial health should be obvious. Any hugely capital-intensive industry needs to plan and invest over many years at a time. While revenue may rise and fall, long-term financial health is a much more significant measure. Murphy and Mark Zmijewski highlight that returns exceeding the cost of capital are essential. After all, without the promise of such returns, how could any industry expect to attract investment?


The forces of competition have driven railroads’ performance and established a safe, economical, efficient, and stable transportation system that ultimately benefits the average consumer. Illogical regulatory restrictions would only be another government “solution in search of a problem.”


If anything, changes are to be made to the STB’s measure of revenue adequacy should be based on a more long-term view of financial health rather than year-to-year fluctuations. 


Still, most analysts believe that the STB has historically done well enough to help pave the way for a competitive, cost-effective, and sustainable rail network. Moving forward, the STB should adhere to the spirit of the mandate given to them by Congress and, at a minimum, resist calls to restrict railroad rates that will unnecessarily impact a stable and unsung industry that delivers the goods for consumers.


Mario H. Lopez is the president of the Hispanic Leadership Fund, a national advocacy organization dedicated to strengthening working families by advancing public policy solutions that foster liberty, opportunity, and prosperity.