The problem was that enforcing market competition did not, in the end, constrain the power of the railroads. Without a strategic, positive effort by the federal government aimed at addressing the fundamental questions posed by a privately run transportation system—how should service best be extended to all Americans?—the railroad companies were able to evade the weak legislation by overwhelming the agency that was supposed to regulate them and litigating over niceties in its language for years.
And because they were natural monopoly businesses, railroads were not constrained by the operation of antitrust law either. The Sherman Antitrust Act of 1890, passed in response to populist concern about the role of titans in business, outlawed “every contract, combination or conspiracy in restraint of trade” and treated violations as crimes.26 But the act represented a compromise written in ambiguous language that provided no guidance as to how it should be applied, and it was little used during the first decade of its existence, despite the tremendous wave of mergers that took place at about that time. Collaboration that squashed rivalry was clearly different from cooperation that promoted growth and advantages of scale and scope. Many courts and economists took the view during the early years of the Sherman Act that unconstrained competition might actually endanger industries with high fixed costs and low marginal costs, like railroads and other utilities.
Even when the Roosevelt administration wielded the Sherman Act in attempts to enforce railway competition it had little effect. A referee enforcing the rules of competition is very different from a manager, and it is difficult to imagine a railway that is not a consolidated, collaborating entity. Policing and facilitating the choices made by private natural monopoly entities operating physical infrastructure used for transportation and communications will not address deep-rooted structural shortcomings in the market economy. Besides, because the Sherman Act is and was interpreted one step at a time by courts, large natural monopoly entities aiming to retain their economies of scale and price-setting power could always keep the fight running for another day.
With his enormous red nose and his shy, imperious demeanor, J. P. Morgan effectively ran U.S. economic policy for decades. Lonely, anxious to please his dead father, and possessed of a strong sense that what was good for his bank was good for America, he advised presidents, wrestled down entire industries, and mastered the art of the holding company. He fervently believed in order and found great satisfaction in the rituals of the Episcopal Church. He believed that unfettered competition in industries (such as railroads) characterized by high initial investment costs was destructive and unnecessary, because the industries’ attempts to underprice one another so as to grab a greater share of a given regional market would systematically destroy any hope of lower average costs for their fixed-price operations and eventually drive all the competitors out of business.27
Morgan knew that his businesses’ monopolistic practices caused great public anger. But to him, as to most of the Gilded Age barons, such a response was naive: the railroads, the web that linked America's great cities together, could function only with the substantial support for investment that protection from price wars provided. Without collaboration and organization of transportation resources, the country would remain a preindustrial backwater.
From Morgan's perspective, pure competition was impossible. True competitors would have to cut workers’ wages in order to service debt, making their businesses unsustainable. At the same time, giant shippers were forcing the railroads to grant rebates and give preference to their distribution needs. In Morgan's view, the railroads had no choice but to operate under unregulated extralegal arrangements supporting both cooperation and rebates.
Under his strong guidance, the railroad barons formed trusts—corporate forms that allowed one entity to serve as an umbrella for formerly competing companies through an arrangement by which stockholders in several companies transferred their shares to a single set of trustees. The first true trust had been created in the 1870s by John D. Rockefeller's Standard Oil in an effort to combine companies acquired by Standard under the same management. As Standard Oil had done, the railroad trust company trustees—usually a handful of Morgan's cronies—handed stockholders holding company certificates.28
Trust arrangements permitted railroad lines to avoid competition by harmonizing their operations, agreeing not to invade one another's territories, and desisting from mutually destructive behavior. The barons argued that the public benefited from the economies of scale produced by eliminating duplicative facilities and by the increased investment in research and development made possible by the huge volume of activities.
Orderliness was, indeed, the way of business at the time: almost 75 percent of the trusts for which the Gilded Age is famous were created between 1898 and 1904.29 Great names like U.S. Steel, Consolidated Tobacco, and Amalgamated Copper came into being at this point. Not just Morgans and Rockefellers but also Vanderbilts, Harrimans, Goulds, and Carnegies suddenly gained extraordinary power over the lives of ordinary Americans. The accumulation of trusts also brought consolidation in utility services: telephone, telegraph, gas, and electric power and light companies joined hands and ceased competing—while simultaneously avoiding government oversight.30 The concentration of ownership also brought a tremendous concentration of affluence; in the mid-1890s, about 9 percent of the families in America owned 71 percent of the wealth.31
Roosevelt viewed this process with dismay. In particular, he was irritated by a trust that had been formed by Morgan, James J. Hill, and E. H. Harriman to bring the Northern Pacific and Great Northern Railways into cooperation. Under Morgan's plan, stockholders of the Northern Pacific and Great Northern companies, railways that together controlled traffic from Chicago to Seattle, were invited to exchange their stock for shares in the Northern Securities Company—the largest business entity in the world next to U.S. Steel.32 Most accepted the deal, and the holding company eventually held about 90 percent of the Northern Pacific stock and more than 75 percent of Great Northern—and controlled almost all railroads west of the Mississippi.33
In 1902, Roosevelt ordered his attorney general, Philander Knox, to bring suit against the Northern Securities Company under the Sherman Act,34 which prohibited any combination “in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce.”35 The suit was a surprise to Morgan and his co-owners. Morgan, peeved, went to visit the president. Roosevelt reported later that Morgan had seemed puzzled. According to Edmund Morris, Roosevelt's biographer, the following conversation ensued:
MORGAN: If we have done anything wrong, send your man to my man and they can fix it up.
ROOSEVELT: That can't be done.
KNOX: We don't want to fix it up, we want to stop it.
Theodore Roosevelt found the exchange illuminating. J. Pierpont Morgan thought of government as just another combination owner—someone with whom a deal could be done, an equal, a peer. Roosevelt believed that moguls should not be the government's equal, and stubbornly moved ahead with a multiyear effort to ensure that the privately operated railroads were subject to constraints that would serve the public interest.36
In 1903, a court in Minnesota backed Roosevelt's use of the Sherman Act.37 This had not been a self-evident outcome; in 1895 the Supreme Court had rejected use of the act against a sugar trust in United States v. E. C. Knight Company. The statute was said to deal with restraint of trade in interstate commerce and not restraint of competition through consolidation of intrastate manufacturing facilities. Because the Knight trust had concerned manufacturing and not interstate commerce, the Court held that it was beyond the reach of the statute.38 Roosevelt's action against the railway trust was the first case under the Sherman Act that involved a merger between competing firms engaged in interstate commerce. But in March 1904, over a strong dissent by Roosevelt's previously loyal appointee Oliver Wendell Holmes, the Supreme Court in Northern Securities v. United States attached “restraint of competition” to the Sherma
n Act, finding by a bare majority that by combining the shares of the Great Northern and Northern Pacific railroads into a single entity, and thus aligning the interests of their stockholders, the Northern Securities Company had suppressed competition and violated the law. Justice Harlan wrote for a plurality of the Court, joined by Justices Brown, McKenna, and Day; his opinion prevailed because Justice Brewer wrote a separate concurring opinion agreeing with its holding but not its reasoning. Justice Brewer set the stage for future antitrust law, rejecting the idea that all mergers that directly restrain interstate commerce were illegal and instead adopting a “rule of reason” approach; reasonable restraints might be legal, and each challenge would have to be determined on a case-by-case basis.
Wall Street was pleased; as the New York Times reported, share prices for both Northern Securities and the Union Pacific rose sharply the day after the decision was announced. Roosevelt's win was perceived by many Americans as a victory for the cause of competition and the role of the national government; the New York Evening Post, less tied to Wall Street than the Times, pronounced it a sharp limit on consolidation: “Surely the most far-reaching benefit of the decision is the vindication of national control.”39
Roosevelt had it both ways; business was relieved and the public was proud. The government would be, at most, a neutral rule maker in the economic realm. After 1909 and until the 1940s, attempts at large regional mergers within the railway industry were blocked by the Department of Justice.
But as the railroads began experiencing economic difficulties, the Transportation Act of 1920 was passed, directing the ICC to create a plan for consolidation of the railway properties of the United States into a limited number of systems.40 Although this mandate was withdrawn by Congress in the 1940s, in the end the Northern Pacific, Great Northern, and Chicago, Burlington and Quincy finally all merged in 1970 to form the Burlington Northern, effectively undoing the 1904 decision of the Supreme Court.41 Warren Buffett now owns the consolidated Burlington Northern Santa Fe enterprise, the second-largest railroad in the country.
Roosevelt's efforts in this area were vitally interesting to the American public. Edmund Morris reports that “Washington resounded with praise, and predictions of four more Rooseveltian years” following the Northern Securities decision.42 As a 1910 essay about Roosevelt by Ernest Hamlin Abbott (in Roosevelt's The New Nationalism) put it, the president had brought about enormous change in public opinion, moving it from a “hard, rather sordid, decidedly materialistic, very complacent,” selfish point of view to a lively, aroused debate about “the whole problem of the control of public utilities,” focused on the “welfare of the farmer” as well as the “welfare of the manufacturers.” This great popular movement was made up of both public feeling and personal leadership “preeminently supplied” by Roosevelt. The president, with his deep affection for the American frontier, had often pointed out that a key characteristic of the frontiersman was his “freedom from provincialism, his feeling that every part of the United States is of concern to him, his desire to uphold the interests of all other Americans.” The American people had cheered Roosevelt on.43
Roosevelt's answer to the lack of enforcement authority and gap in price-fixing capability given to the Interstate Commerce Commission was administrative oversight. As he said to Congress in his State of the Union Address of 1904, “The Government must in increasing degree supervise and regulate the workings of the railways engaged in interstate commerce; and such increased supervision is the only alternative to an increase of the present evils on one hand or a still more radical policy on the other.”44 The legislation he championed, the Hepburn Act of 1906, gave the ICC the power to set maximum rates and to forbid rebating. Because some railroads gave preferential rates to commodities in which they had a financial interest, the Hepburn Act also included a clause prohibiting railroads from hauling commodities they produced or owned, or in which they had a financial interest. Later, the Mann-Elkins Act of 1910 added to the ICC's arsenal the power to block proposed changes in shipping rates.45
The ICC was supposed to be an independent entity, operating separately from the legislature, administering technical matters in rates and facilities with a high degree of autonomy. The idea was that such an agency could better respond to changes in the relevant conditions with flexibility, precision, and expertise; no broad legislative wording could accomplish this same goal as well. In the end, the regulation of railroads accomplished less than many had hoped. As the first regulatory agency, the ICC also became the first victim of regulatory capture: it was completely overrun by the industry it purported to regulate.
According to an article by Samuel Huntington (“The Marasmus of the ICC”) published in the Yale Law Journal in 1952, the decade after the passage of the 1906 act was a golden era for the ICC; by the start of World War I, the Commission had eliminated the worst of the railroads’ discriminatory practices. But the railroads were nationalized during the war, and afterward they decided that “the path of wisdom was to accept regulation and to learn to live with the Commission.” The shippers (the traditional enemies of the carriers) grew lax, less interested, less politically active. Farms were being wiped out by urbanization. And neither President Harding nor President Coolidge was interested in restrictive regulations. So the Commission looked for support in the only place it could find it: from the railroad industry itself. The railroad management group had all the information the Commission needed; it supported the growth of the Commission's agenda and defended the Commission against executive intrusions. As Huntington put it, “The attitude of the railroads towards the Commission since 1935 can only be described as one of satisfaction, approbation, and confidence. At times the railroads have been almost effusive in their praise of the Commission.” Huntington charged that to shore up the railroad industry's support for its operations the ICC had permitted the railroads to raise rates, refused to investigate railroads, facilitated the reduction of competition, favored railroads over motor carriers, and generally acted in a passive, dilatory manner. Huntington recommended flatly that “the Interstate Commerce Commission … be abolished as an independent agency.”46 Coziness, mutual dependence, and stark asymmetry of information—the railways had all the data—had caused the ICC to deteriorate, and by the 1970s, it was on the way out: Congress passed several laws aimed at deregulating the shipping industry, which diminished the Commission's authority. In 1995, the ICC was abolished and its functions were transferred to the Surface Transportation Board within the Department of Transportation—not itself a model of disinterested civil oversight.47
Nonetheless, the idea of regulation by expert commission provided the rationale for the Federal Communications Commission (FCC), created in 1934 on the model of the ICC.48 The ICC also established a central organizing principle for constraining the power of a private company serving public interests in basic transport and communications: common carriage.
“Common carriage” is an old idea. It is a label attached to private basic transportation and communication businesses that are “affected with the public interest.” For hundreds of years, operators of ports, bridges, ferries, and the like operating through a license with the sovereign have historically had a duty to serve all comers and serve them equally. As long as companies in the business of providing basic transport and communications—such as taxi and telephone companies—portrayed themselves as serving the public, and as long as they were clearly in the business of taking parcels or conversations from Point A to Point B, they were obliged to serve all comers fairly and equally. By the 1870s, state legislatures making rules about railroad carriers had picked up on the traditional principle that industries “clothed with public interest”—companies that provided basic, essential transport and communications facilities—were subject to government oversight. The Interstate Commerce Act of 1887 gave the Interstate Commerce Commission explicit jurisdiction over “common carriers”: if a shipping line or a railroad was ceded a natural monopoly, it had to o
ffer to all comers equal service and submit its rates to the Commission for approval.49
Such nondiscrimination rules were applied to American telegraphy providers from the mid-nineteenth century on, and to telephony providers when they started business in the late nineteenth century. Regardless of whether the telegraph or telephone system was too small to have any chance of dominating a market, it was still obliged to serve every customer on equal, reasonable terms. It was a private business with public effects. It was conduit, not content. Common-carriage regimes give us confidence that we can trust private providers of essential communication services not to discriminate or censor; this framework facilitates competition (the free market has a field on which to operate), forwards personal and commercial freedoms—and lowers barriers to businesses by eliminating one-off negotiations for each transaction. The tradeoff for the carrier is that it avoids liability for the content of the packages (or messages) that it carries.
So when Congress (spurred primarily by the secret rebates, predatory pricing, and collusive activities of the railroads) added telephone systems to the Interstate Commerce Commission's responsibilities in 1910, it simply treated telephone and telegraph companies like railroads, declaring them all to be common carriers. Both railroads and telephones had been given access to extensive public lands and had benefited from the power of the state to condemn property for their use; in exchange, they had to offer their services without discrimination to all comers, and their rates would be set by the ICC.50
Captive Audience: The Telecom Industry and Monopoly Power in the New Gilded Age Page 4
