Trillion Dollar Economists_How Economists and Their Ideas have Transformed Business

by Robert Litan

  Dorothy Robyn’s classic history of trucking deregulation (and later deregulation overall) pithily describes the chain of events that led to the industry’s regulation, and although she doesn’t explicitly embrace public choice theory as the explanation, her recitation of the facts demonstrates, at least to this author, the usefulness of the public choice framework.13

  As Robyn tells it, the growing competitive threat posed by trucks to rail was not clearly evident until after World War I, during which the railroads were temporarily nationalized to support the delivery of men and equipment to their points of ocean departure for Europe. By the time railroads were returned to private hands in the 1920s, trucks had rushed into the vacuum for transporting goods and they clearly were a competitive force to be reckoned with. Using a time-honored tactic of harnessing the power of government to thwart competition, railroads first lobbied the states (reflecting the relatively weak power of the federal government at that point in history) to restrict entry into trucking and to set both maximum and minimum rates they could charge. By 1925, 30 states had enacted such regulatory restrictions.

  The Supreme Court intervened by restricting the power of states to control interstate trucking traffic—the most important competitive threat to railroads that routinely crossed state lines—as a direct intrusion on the power of the federal government to regulate interstate commerce. So the railroad industry switched tactics, supporting a federal bill drafted by the national body representing the state utility commissions that gave states primary power to regulate trucks, while allowing appeals to be made to the ICC that then regulated rail. Truckers and labor opposed the bill. Advocates of public choice theory can claim victory with both stances: The railroads were acting in their economic interest to limit competition from a new technology and so wanted regulation, and they were opposed by the firms and employees using the new technology (trucks). It all made sense, but it also made for a standoff. The railroad-backed utility commissioners’ bill went nowhere in Congress, until the Depression.

  Then things changed, backed by President Roosevelt, who despite his reputation for being an antibusiness president, sided with the railroads, fearing that cutthroat competition between the railroads and the trucking industry would cause only more unemployment in the midst of the Depression. Even many truckers (but not the entire industry or the manufacturers that made trucks) switched sides and supported Roosevelt’s National Industry Recovery Act (NIRA), which put most of the economy under the thumb of the government, but not the previous bill giving regulatory authority over trucks to the ICC that was perceived to be too much in the pocket of the railroads. Only after the Supreme Court struck down the NIRA as unconstitutional did the trucking industry give its support to what became the Motor Carrier Act of 1935, which put trucks and rail under the regulatory control of the ICC. In 1948, Congress followed up by effectively delegating rate making authority for trucks to collective rating bureaus (analogous to similar arrangements in the insurance industry, which were sanctioned in the McCarran–Ferguson Act of 1944).

  It is difficult for readers under the age of 40 or so, or those who never would have experienced the impacts of trucking regulation, to appreciate the complexity, indeed craziness, of what regulation of the trucking industry became. Imagine a world in which the nature of the cargo and prices for moving it were approved for every departure and destination. In such a world, trucks could carry goods one way, but had to return empty, or maybe half-full, because authority to carry full loads on that same return route would have been given to other firms. Imagine how such a world would or, more accurately, would not have accommodated the rise of Internet retailing and the transformative impact it has had on the U.S. economy. Hold that thought in your head until I resume discussing the impact of trucking deregulation on the American business landscape later in this chapter.

  Even more so than with airlines, the obvious question is: How was it ever going to be possible to eliminate regulation of trucking? Unlike airlines, whose fares voters actually paid, the costs of truck shipments were (and still are) hidden in the price of goods that consumers pay. Only buyers of supplies and retailers pay trucking costs, and these can generally be passed on to the next purchasers. Moreover, to the extent deregulation of trucking would reduce shipping costs, the benefits to each buyer of trucking services would be small, as compared to the potentially large cut in wages, and possibly profits, earned by many truckers. Normally, such an imbalance in benefits and costs explains why status quos remain.

  But the late 1970s were different and unique in several respects. First, once airline deregulation had been enacted, a precedent had been set for deregulating an even more diffuse industry, namely trucking, which clearly had no natural monopoly characteristics. Second, with Senator Kennedy again on board, the Carter White House took advantage of the momentum established by airline deregulation by helping to organize shippers and consumer groups to put pressure on Congress to take the next logical step and deregulate the trucking industry. Third, the ICC under the leadership of A. Daniel O’Neal in the early years of the Carter presidency took some initial administrative actions to loosen trucking rules, a process that his successor in 1980, Darius Gaskins, greatly accelerated. This was no surprise because Gaskins worked for Kahn at the CAB and, like Kahn, saw the virtues of a competitive, unregulated trucking market and persuaded his fellow commissioners of this view. Fourth, the general economic atmosphere at the time, another horrible episode of stagflation following the large increase in oil prices in 1979, had a silver lining for advocates of deregulation: It allowed them to claim that deregulation, which promised lower shipping rates, was needed to fight inflation. Alfred Kahn, by that time the administration’s inflation czar, and Charles Schultze, the chairman of Carter’s Council of Economic Advisers, were among those leading the charge for legislative deregulation using anti-inflation arguments.

  It took all four of these factors to overcome decades of inertia, culminating in the passage of the Motor Carrier Act of 1980, signed into law by President Carter in July 1980. The Act eliminated government-sanctioned rating bureaus from setting interstate trucking rates (some states still maintained vestiges of intrastate controls after the 1980 Act), removed most restrictions on the commodities that specific truckers could carry, and got the government out of the business of approving routes and geographic territories for trucking firms. The Gaskins-led ICC moved aggressively after the Act to implement its key provisions.

  Darius Gaskins: Multitalented Deregulator and Executive

  Darius Gaskins is a unique economist, having achieved success in academia, government, and business. But like others featured here, his ascent to the top did not follow a straight line.14

  His ultimate path certainly was not evident at the outset. A West Point graduate, he served as an engineer in the Air Force in the 1960s, working on the nation’s space program. After the base on which he was serving shut down, Gaskins pursued his other passion, public policy, and thought he would make the most contribution (like many other economists, including your author) if he earned his PhD in economics. He went to a school known as much for its engineering as for its economics, the University of Michigan, and that is exactly what he did next (after obtaining a master’s in engineering from the same school first).

  Like other PhD economists, Gaskins went first from graduate school into the academy, the University of California at Berkeley, but didn’t stay long. Following his passion for policy, he held a series of federal government jobs in the 1970s, at the Interior Department and the Federal Trade Commission where he became chief economist, before being enticed by Fred Kahn to be chief economist at the CAB. Once deregulation had been accomplished, Gaskins moved on to become chief of policy at the Department of Energy.

  Kahn was instrumental in persuading the White House to nominate Gaskins for chairman of the ICC, a job in which he served from 1980 to 1981. During his short but highly influential tenure, Gaskins oversaw trucking deregulation, both adminis
tratively and with Congress, to help enact the Motor Carrier Act of 1980.

  After his government service, Gaskins was attracted to the private sector, where he first took a job as a senior vice president at the Burlington Northern Railroad. He assumed the presidency of that company in 1985. Since 1991, Gaskins has been active in management consulting, and is a founding partner of Norbridge, Inc.

  Railroad Deregulation

  The deregulation of the railroad industry, for both passengers and freight, was different and easier than for airlines and trucks, because in this case, the industry wanted to be out from under the government’s thumb. As we will see later, the industry, and the policy makers who listened to them, turned out to be right.

  The introduction of regulation for rail differs from other industries, because it was motivated by a legitimate desire to curtail monopoly pricing by railroads in the late nineteenth century. As that monopoly eroded—due to stiff competition from autos for passengers and from trucks for freight—the case for having the ICC continue restricting entry while allowing the railroads themselves to set rates (a delegation of price regulation to the industry) also eventually fell apart. But it took an existential threat to rail for change to occur.

  Given the rigidity of the collective rate making for railroad fares, railroads steadily lost traffic from the 1930s through the 1970s to other transportation modes, and for a number of railroads profits turned to losses. Deregulation was the only obvious answer to the industry’s problems and it happened in two stages.

  In 1976, Congress gave railroads some pricing freedom in the Railroad Revitalization and Regulatory Reform Act (known as the 4R Act). But shippers wanted more flexibility to negotiate their own deals with railroads. This is what they got when the Staggers Rail Act of 1980 was shepherded through Congress by the chairman of the House Commerce Committee, Representative Harley Staggers. This Act effectively deregulated virtually all aspects of the rail industry, except for safety and a requirement that railroads with bottleneck tracks or facilities give access to connecting rail lines (similar interconnection requirements were later imposed on regional telecom carriers after the breakup of AT&T and by the Telecommunications Act of 1996, subjects discussed in Chapter 11).

  The route to passage of the Staggers Act was facilitated not only by industry support, but also by the momentum generated by the deregulation of the airline and trucking industries. If these two industries, which competed with railroads, could operate freely, it was hard to argue that railroads shouldn’t be given the same treatment. Finally they were.

  Deregulation’s Impact: The Transportation Industry

  The deregulation of prices and entry in all sectors of the transportation industry has accomplished what the economists who supported it said would happen: It has lowered prices. One of the nation’s leading transportation economists, Clifford Winston of the Brookings Institution, by himself and with colleagues, has documented this result in multiple academic publications, using a methodology that is now recognized as the gold standard in the way to conduct such studies.15 Rather than simply look at prices or price trends before and after deregulation, Winston and his colleagues have constructed models to project what prices would have been in absence of deregulation and compare them to actual prices. Only by looking at these counterfactual examples can one know with any certainty whether deregulation has actually lowered prices. Nonetheless, it is still useful information to know that the pre- and post-deregulation data for airline prices, in particular, make clear the dramatic benefits deregulation delivered to consumers. Between 1978 and 2011, the real or inflation-adjusted passenger revenue yield (an average price measure commonly used in the industry) fell by almost one-half.16

  Deregulation of transportation did have some unexpected results for the industries themselves, however, especially the airline industry, where at times the deregulation policy has been questioned (though it never has been reversed). The development of the hub and spoke system for airline routes was one unanticipated result, which on the whole has been a good thing by enabling travelers from non-hub locations to gain more frequent access to multiple destinations by flying to the nearest hub. Frequent flyer miles, a method airlines have used to ensure greater customer loyalty, was also an unanticipated result and a mixed blessing. Other things being equal, such customer loyalty arrangements can frustrate the ability of new entrants to entice customers away from established airlines, which diminishes competition. Nonetheless, even with these loyalty programs, the research shows that, on balance, average airfares are lower than they would have been under the old regulated system.17

  A third development, which was entirely anticipated given the decline in fares, is much higher load factors, and thus less comfortable flights. Many readers may be too young to have experienced air travel when it was fashionable: People actually dressed up to fly. But because of its expense, air travel was limited to those with higher incomes and wealth. With deregulation, and the much lower fares it has brought, the panache has gone out of air travel—to put it mildly.

  What is worse, at least from the passengers’ point of view, is that in their quest to become profitable, airlines have substituted smaller, more fuel efficient, but less comfortable regional jets for the older, larger jets that the airlines used to fly. This source of reduced comfort is not deregulation’s fault, however, since even in a regulated environment, airlines probably would have reacted pretty much the same way in response to higher fuel costs (unless the CAB would have approved passing on the higher costs to consumers).

  Another result of deregulation that I do not believe was widely anticipated is the large variation in fares for essentially the same seats on the plane. This outcome was produced by yield management techniques that vary prices by when reservations are made. Airlines have also unbundled their services, generating another reason for fare variation. Passengers wanting a no-frills experience sitting at the back of the plane pay the least, while those wanting food, checking or carrying on baggage, entertainment, Internet service, and better seats, pay more for each of these items. Each of these developments—more fuel-efficient planes, unbundled pricing and service, and yield management—have led to much fuller planes, which has finally enabled many airlines to make money.18

  It has taken a long time to get to this point, which many would say was unexpected. It is less surprising, however, if one considers the long time it has taken for the airlines to adjust their highly unionized workforces to a deregulated and more competitive environment. In this effort, the airlines ironically have been aided by multiple bankruptcies, which have afforded them leverage to gain concessions from unions, often repeatedly and by damaging employee morale. Another cost to the bankruptcies is that bankrupt airlines can keep flying while under judicial protection from their creditors. This has intensified competition, complicating efforts by all airlines to turn a profit. One response has been a rash of mergers, which airlines have sought in order to spread their fixed costs over larger route structures and passenger bases. The Department of Justice mostly accepted this consolidation until 2013, when the Department challenged the merger between US Airways and American Airlines. Like most challenged mergers in the past, this lawsuit was never tried because the parties worked out a plan of route divestitures (at this writing, the settlement had not yet been approved by the courts since some critics of the deal argue that DOJ gave too much to the merging parties).

  Since airline deregulation was launched the industry has been in a constant state of upheaval. At first, a number of low-cost airlines entered the industry but, with the exception of Southwest, few have succeeded. Readers old enough may remember once popular upstarts like People Express and New York Air that have since disappeared, indicating that creditors are more apt to force liquidation of a new airline than a previously well-established carrier. A few newer airlines that offer better service, like Jet Blue, Alaska Air, and Virgin Air, nonetheless have survived, at least as of 2014 (Virgin’s rights to fly domestical
ly are severely restricted because it is a foreign carrier and the United States still has not liberalized much foreign carrier entry into the domestic market).

  Developments in the air cargo side of the industry following deregulation have been more predictable but also revolutionary. FedEx has grown into one of the largest transportation companies in the world, followed closely by UPS. Both established integrated air and truck transportation systems, so they could deliver packages directly to their destinations rather than having to hand them off to another mode. This kind of integration, and the efficiencies and customer conveniences it has brought, never would have happened without deregulation of both airline and interstate truck travel.

  As for trucks, all of the predictions about deregulation in this industry—which was never a natural monopoly—came true for both segments of the industry, TL (trucks loaded full) and LTL (trucks that are less than full). With entry controls gone, the number of TL companies exploded, from about 20,000 in 1980 to 55,000 in 1995. LTL truckers, meanwhile, gained much more flexibility without the regulationera commodity traffic approval process. All in all, the industry became much more competitive and rates dropped, by at least 25 percent and perhaps more.19

  Likewise, railroad deregulation also led to a major drop in freight rail rates, according to the Government Accountability Office, which also reported an increase in rail profitability.20 How could that be? Because the drop in rates induced a substantial increase in traffic, as rail became a more viable competitor to trucks for freight shipments.21