The Transports Regulatory Reforms and the Influence of Market Forces - Essay Example

 Transport deregulation Act of 1978 has affected public policies in such a manner that has resulted in reducing the control of the federal government and of carrier rate associations on the conditions of competition, particularly in the airline and trucking industries. In particular, the transport regulatory reforms embodied in the 1978 Acts allowed Greater freedom of entry into the industries of land sea and air, Greater freedom of entry into, and of exit from, particular markets, and Greater freedom of individual ratemaking. “The Act significantly increased the influence of market forces on the prices charged for air, sea and truck service and the profitability of individual firms. Increased rate competition among motor carriers directed the effects on the rates charged by railroads for the movement of high-value goods and indirectly effected on all other tariffs”. (Moses, 1989) One of the main reasons for passing regulatory reform bills was to make the lawmakers realize that increased competition would lead to more efficient operations that would not only lower rates in the air, land and sea industries but would also not compromise upon safety issues or quality of service. “Some changes in quality of airline service were, in fact, hoped for. It was commonly believed that after deregulation 1978, the suppression of price competition by the Civil Aeronautics Board (CAB) would foster competition in service quality variables that would be highly uneconomical, such as too early replacement of aircraft and departures at major airports that were excessive in light of existing load factors. It was also asserted that such quality competition would drove the costs up, which would led to proposals to the CAB for relief in the form of fare increases. However, the positive effects of such increases (which were almost always granted in the past before deregulation) on the profitability of airline operations were soon dissipated by another round of quality competition and increased in costs of operation”. (Moses, 1989) Rail Industry: In the rail industry, nevertheless, the essence of the regulatory transition problem was never summarized and the expectations were not fulfilled. Presently, the rail industry is subject to substantial sunk costs, since assets are long-lived and specialized to certain geographic markets. Much of the traffic is subjected to effective competition from competing railroads, modes of transportation, origins and destinations, or products. Some shippers, however, are successful in transporting commodities for which rail have a substantial competitive advantage over competing modes, even if they are available in principle. Further, after 1978 deregulation Act these shippers have sunk considerable costs in specific locations or signed contracts with customers or vendors, which make them captive to individual railroads. The difficult problem in the transition is to permit maximum leeway for competitive forces while maintaining a substitute for the regulatory protection that was relied upon by captive shippers when they sank costs. These long-term investments were initially made by the shipper with the presumption of continued regulation and thus without the usual contractual protections against “opportunistic behavior” by the carrier in such circumstances”. (Baker et al, 1991, p. 12) “In the rail industry, after 1978 the ICC does not now assume jurisdiction over rates unless it has made a determination that the rail carrier possesses market dominance over the traffic. Section 4 addresses issues in market dominance determination, particularly the role of the revenue/variable cost ratio”. The history of railroad regulatory policy may be largely summed up as an attempt to resolve the conflicting objectives. Shipper interests believed they had granted major concessions to deregulate competitive traffic and to achieve revenue adequacy, while receiving in return residual regulation to protect captive shippers and guarantees that captive shippers would not be required to fund losses for certain categories of competitive traffic. When the U.S. Interstate Commerce Commission (ICC) began to institute a series of decisions that many shippers believed to have eviscerated the guarantees supposedly incorporated in the legislation, they found these decisions were based upon the theories of Ramsey Pricing and contestable markets, which were alarming for two major reasons: (1) They had the consequence of undermining the competition that was the initial rationale for deregulation, and (2) “They threatened a successful transition to deregulation by the regulatory reform literature that has rightly condemned much of this attempt to eliminate price discrimination, some of which was the natural result of short-term disequilibrium that would eventually have cured itself had regulatory constraints not interfered. A successful transition to deregulation, however, is often threatened by the belief that extreme forms of price discrimination are the answer to the problems of the transition to deregulation. This in turn gives rise to perverse and unexpected demands for residual regulation during the transition”. (Baker et al, 1991, p. 21) “In case of both regulation and the transition, tendencies arise in order to consider substantial price discrimination as consonant with an idealized welfare norm. At the same time, the severe deviations from a highly competitive or contestable environment such as restrictions on entry, franchised monopoly, cross-subsidies, or sunk costs that facilitated the price discrimination and restricted the options of those disadvantaged by it were forgotten. In the particular case of railroads, moreover, Ramsey Pricing and the SAC test failed as transition mechanisms because the SAC test starts with an artificial attempt to force the transition problem into the mold of contestability theory in an industry where, according to most observations, “hit and run” entry by specialized competitors with cost structures identical to those of the incumbent is somewhat limited. Indeed, if far more competitive and easy-to-enter transport markets, such as trucking and airlines, do not achieve full contestability, then the difficult-to-enter railroad market should fall significantly short of that ideal”. (Baker et al, 1991, p. 21) “The railroad industry in the latter half of the 19th century had earlier experienced each of the problems that advocates of airline regulation wanted to guard against. Vertical integration by such men as Jay Gould had enabled control of markets between two points, with disastrous consequences for consumers to whom he could charge anything he wanted. Rate wars between competing railroads had also wrecked companies, with a long slow climb out of receivership following. Piecemeal attacks on these problems from various state legislatures created a patchwork quilt of regulations that varied from jurisdiction to jurisdiction, but since the problems were inherently interstate in focus, these efforts failed to bring resolution. The consequence was that by the 1880s many officials of both the railroad industry and the federal government were advocating national regulation to bring order to the chaos. It came with the creation of the Interstate Commerce Commission in 1887 and found refinement thereafter”. (2006a) “The freight railroad sector is strong and meets the nation’s current demands for rail service.  Four major companies move over 85 percent of all rail freight traffic in the United States.  Union Pacific and Burlington Northern/Santa Fe (BNSF) operate west of the Mississippi River while CSX and Norfolk Southern dominate the East.  However, future capacity expansion is difficult due to the high cost of infrastructure and limited availability of land.  After 1978, the rapid expansion of inter modal operations and the growth of traffic at United States ports are providing both challenges and opportunities to this sector”. (2006b) “Amtrak, the nation’s long-distance passenger rail carrier and a public corporation, continues to operate at a deficit despite significantly improved operations and record levels of rider ship.  Of much greater importance to the U.S. economy is the growing commuter rail and subway systems that relieve highway congestion, reduce pollution, and serve people who don't have access to personal vehicles”. (2006b) “Security concerns within the railroad sector continue to increase, highlighted by the terrorist bombing in Madrid, Spain in March 2004 which killed nearly 200 people.  New technology is being tested for eventual passenger screening, but securing thousands of miles of track, thousands of rail stations, and high density commuter traffic requires massive funding that must be prioritized”. (2006b) Air Industry: “Air transportation offered essentially the same challenges and resolutions posed by the railroads a half century earlier”. (2006a) “Among the CAB’s functions, one of the most important was to pick airlines from the available pool for a particular route rather than let the market decide which airline should fly that route. 1978 Act enabled established carriers already serving a route evaluate new applicants and often found that the applicant lacked some requirement for flying an already-covered route. Thus, new entrants into the business were at a great disadvantage and were often shut out of key routes since the established airlines did not want new competition. Fare-setting also involved a similarly long process. In the airline industry, there was a general level of discontent about the laws that regulated civil aviation. Furthermore, discussions in Congress highlighted the fact that fares for routes within states were often much lower than fares between states, even if the actual routes were the exact same distance. This was partly because national routes were regulated to a much stricter degree then flights within states”. (2006a) All of the events after regulation proved to be favorable for large-scale deregulation. “In November 1977, Congress formally deregulated air cargo. In late 1978, Congress passed the Airline Deregulation Act of 1978, legislation that had been principally authored by Senators Edward Kennedy and Howard Cannon. There was stiff opposition to the bill from the major airlines who feared free competition, from labor unions who feared nonunion employees, and from safety advocates who feared that safety would be sacrificed”. (2006a) Thus deregulation Act of 1978 had to undergo many critics and was confronted to many problems from all sides. “Public support was, however, strong enough to pass the Act. The Act appeased the major airlines by offering generous subsidies and it pleased workers by offering high unemployment benefits if they lost their jobs as a result. The most important effect of the Act, whose laws were slowly phased in, was on the passenger market. For the first time in 40 years, airlines could enter the market or (from 1981) expand their routes as they saw fit. Airlines (from 1982) also had full freedom to set their fares. In 1984, the CAB was finally abolished since its primary duty, that of regulating the airline industry, was no longer necessary”. (2006a) The effect deregulation possessed in the short and long term can be seen by analyzing many airlines, including those who abandoned less profitable routes that took passengers to smaller cities. “For example, until 1978, United Airlines had flown to Bakersfield, California, a booming oil town of 225,000 people. With deregulation, United pulled out of Bakersfield, depriving the city of any flights to bigger cities such as San Francisco or Las Vegas. A second and related effect was the growth of “hub-and-spoke” routes. The major airlines “adopted” key cities as centers for their operations; these key cities served as stops for most flights, even if they were not on a direct route between two other end points. Delta Air Lines had a major hub at Atlanta while Eastern ran its hub operations from Miami. Both airlines ran many daily roundtrip flights from their hubs, thus keeping planes in the air for more hours each day and filling more seats. For example, the number of daily nonstop flights between New York and West Palm Beach, Florida, jumped from five to 23”. (2006a) Deregulation also enabled new start-up airlines to enter the market in order to immediately compete with established airlines without even agreeing to the demands of the larger established airlines. “One of these was People’s Express, founded by Donald Burr, an entrepreneur who introduced unconventional methods of management such as low salaries, fewer managers, employees who could perform multiple jobs, and equitable stock ownership by all employees. Burr ran an extremely tight operation where passengers had to pay for meals on planes and were charged for checked-in baggage. Fares were so low that they were comparable to intercity bus lines. People’s Express revenues increased dramatically through the early 1980s, reaching a billion dollars by 1985. Eventually, though, People’s couldn’t compete with established airlines that also cut their prices but offered significantly better service. The older airlines, being linked with travel agents, also offered the option of advance ticket purchases. Within a year of reaching its peak, in 1986, Burr had to sell People’s Express in the wake of rising losses and passenger dissatisfaction”. (2006a) “The landmark Airline Deregulation Act of 1978 benefited consumers as fares dropped by one-third from 1977-1992”. (2006b)  Shipping Industry: No doubt that global shipping was on its peak before deregulation Act 1978 on a “cyclical upswing due to booming Chinese trade and economic growth in much of the rest of the world.  Increase demand for oil and the growth of free-trade agreements magnified this upswing.  Shipping companies started managing this growth by purchasing larger ships and seeking ports with greater offload capacity, often necessitating terminal growth and harbor dredging.  The steady growth of container traffic drove the expansion of the rail and road inter modal networks to expedite the flow of goods inland.  One important example is the recent completion of the $2.4 billion Alameda Corridor project that links the ports of Los Angeles and Long Beach to transcontinental rail lines, greatly expanding the throughput of those ports”. (2006b) “In contrast to the growth of global shipping, inland waterway use has declined by 30 percent over the past years due to deregulation, due primarily to the convenience of other modes such as trucks and railroads.  While traffic congestion and pollution concerns make inland shipping attractive, the system’s limited waterway network and the expense of infrastructure improvements hampered expansion”. (2006b) The effect of deregulation is seen in a negative manner among the privately owned U.S. merchant fleet, which has decreased by half over the past couple of years, “significantly increasing our reliance on foreign flag vessels.  Currently, only about 4 percent of U.S. exports and imports are carried by U.S. flagged vessels.  Foreign built and operated ships offer shippers lower operating and maintenance costs at the expense of the U.S. maritime industry.  Government programs and policies such as the Jones Act, Maritime Security Program, and Cargo Preference Act help ensure that a small number of U.S. flagged vessels remain in service”. (2006b) Trucking Industry: Trucking has always played a vital role in the transport of goods, as it is the only mode that serves most communities in the United States.  Today, “the sheer magnitude of trucks serves to dominate many aspects of transportation services. In 2003, trucks moved almost 70 percent of the domestic freight, totaling 9.1 billion tons of cargo” (2006b), and to some extent this advancement in trucking is due to the 1978 deregulation Act. “Trucking companies has faced stiff competition that resulted in low profit margins of about 2 to 4 percent.  Low barriers to entry and exit resulted in numerous trucking company start-ups and failures each year, for a dynamic and ever changing landscape. In addition, the industry has seen many mergers as companies fight to gain competitive advantage. Despite these low profit margins, the industry has continued to prosper because of improving economic conditions based on the benefits provided by deregulation as personal consumption, business orders, and reduced inventory quantities.  As with the other transportation sectors, rapidly rising fuel prices escalate operating costs, particularly for small carriers operating on slim profit margins”. (2006b) The impact of deregulation Act on the trucking industry is significant: The number of trucking companies increased dramatically. Existing carriers expanded into new services with new routes, and new smaller carriers entered the business. The number of interstate motor carriers increased from 18,000 in 1975 to over 500,000 in 2000. (2006c) The industry restructured itself. Truckload (TL) carriers, no longer restricted to set routes and commodities merged and consolidated to provide national coverage. Less-than-truckload carriers (LTL), under attack from TL carriers intent on carving off large-lot shipments, shrank and streamlined their operations. And the use of private carriers (i.e., company-owned or ‘in-house’ trucking fleets) declined as companies chose to take advantage of the lower rates and improved services offered by newly competitive for-hire carriers. (2006c) Lower trucking prices benefited the U.S. economy as a whole. Prior to deregulation, trucking expenditures were 5.7 percent of GDP, while in 1997 they were less than 5.0 percent. This is the equivalent of $60 billion saved in national income. (2006c) Trucking share of the freight market expanded. Today, the trucking industry has 80 percent of the U.S. freight transportation market by revenue although the railroads still carry the largest share by tonnage. (2006c) References Baker Alexander Miriam, Kolbe A. Lawrence, Leonard B. Herman, Meyer R. John & Myers C. Stewart, 1991. “The Transition to Deregulation: Developing Economic Standards for Public Policies”: Quorum Books: New York. Moses N. Leon, 1989. “Transportation Safety in an Age of Deregulation”: Ian Savage: Oxford University Press: New York. 2006a, accessed on July15, 2006 from 2006b, accessed on July 15, 2006 from 2006c, accessed on July 15, 2006 from Read More