Leading up to 1980, economic research had demonstrated that regulation created noticeable cost and price increases. Policy advocates and policymakers took note.
Pre-deregulation rail studies identified two sources of inefficiency: misallocation of resources associated with rate regulation (deadweight loss), and inflated costs created by route regulation and other restrictions on lower-cost technologies and business methods.
These inefficiencies corresponded to the economic distinction between allocative efficiency—created when prices more closely reflect costs—and productive efficiency—created when firms develop new products, new services, new sources of supply, or new methods of organizing production.
The effects of regulation on productive efficiency far exceeded its effects on allocative efficiency. Most empirical studies estimated annual deadweight losses somewhere between $175 million and $900 million in the 1970s. Studies also estimated that regulation inflated railroad costs by up to $6.7 billion annually. This figure came from an empirical assessment of the effects of regulation on U.S. railroads’ productivity—the broadest measure of technical progress. The researchers concluded that “losses from foregone productivity growth are much larger than losses from the misallocation of freight traffic.”
Regulation also frustrated railroads’ efforts to cut costs and attract new business.
In 1960, for example, the Southern Railway introduced its “Big John” covered hopper car for grain. Since these cars were larger and more efficient, Southern sought to cut its grain shipment rates by more than half. The ICC resisted these rate reductions, and Southern had to litigate its case up to the U.S. Supreme Court. Similarly, regulation frustrated railroads’ efforts to offer rate reductions for multi-car shipments or introduce unit trains of hopper cars that hauled coal.
Economic deregulation of railroads was motivated largely by the industry’s financial crisis and congressional unwillingness to commit to perpetual subsidies for freight rail service.
By the late 1970s, railroads’ return on equity averaged 2.5 percent, and railroads in bankruptcy ran 21 percent of U.S. trackage. The 1970 Penn Central Railroad bankruptcy was the largest corporate bankruptcy at that time. Penn Central was merged with five other northeastern carriers to create Conrail, which received more than $7 billion in federal subsidies before it was privatized through a public stock offering in the late 1980s.