Disambiguating Impacts of U.S. Railroad Deregulation by Robert Gallamore

I. Positive Effects and Benefits of Deregulation

1. By moving most railroad operating decisions (pricing, financing, services) out from under from the purview of Federal regulatory agencies and, instead, allowing them to be governed by the private marketplace, partial economic deregulation of railroads rewarded consumers and the U.S. economy with historic levels of improved railroad economic performance. Partial rail deregulation returned everyday business decisions on pricing, investments, and service offerings to the owners and operators of railroad companies, enabling railroads to speed adjustments to new opportunities in the marketplace. Deregulation permitted lower costs for railroads and lower rates for shippers.

2. American railroads had been in deep decline throughout the Twentieth Century, as measured by losses of freight and passenger market share, employees, track mileage, and stock market value – until passage of the Staggers Rail Act of 1980 triggered a Renaissance for the industry. The Staggers Act was the core piece of legislation reversing traditional Interstate Commerce Commission (ICC) regulation of railroads, and at the heart of deregulation was the new freedom for carriers and customers to enter into rate and service contracts. These had been considered a form of discrimination, and hence illegal, under ICC regulation. Contracts were the means by which carriers and shippers could agree on ways to match supply and demand, saving costs and
providing greater value.

3. Federal regulation of railroads began in the Act to Regulate Commerce (1887), although many states had set up Railroad Commissions to issue railroad charters and oversee operations within their borders earlier. Interstate Commerce Commission (ICC) regulation was conducted under a long series of statutory rules and precedents designed for an earlier era with vastly different transportation challenges. Regulatory decisions were made in court-like adversary settings by political appointees who often came under the influence of special interests.

4. Partial economic deregulation under the Staggers Act made it clear that railroads could act like other businesses in choosing their markets, pricing their products, and contracting with customers for terms of service. Railroads were encouraged to find new sources of traffic, innovative ways of operating, and to improve profitability of underperforming traffic segments. The result was a better and quicker match of railroad supply capabilities to market demands and opportunities. Although politicians generally feared that deregulation would allow railroads to charge much higher rates, the actuality was quite different. Average rates unambiguously fell by about fifty percent in the deregulatory period. (See chart below).

5. Lower rates and the freedom to enter into long-term rate and service contracts (previously illegal under ICC regulation) induced new traffic. Also in the Post-Staggers period, railroads benefitted from a boom in western low-sulphur, long-distance unit-train movements of coal. The strong dollar and new international trade agreements stimulated development of international containerized intermodal traffic to ports and domestic distribution centers. New tax rules for handling accelerated depreciation of old frozen railroad assets infused cash into the industry. A Presidential Emergency Board ruling (PEB-219) in 1989 allowed railroads to operate trains with smaller crews.

6. Improved cash flows from deregulated operations enabled railroads to spend more earnings on, or reinvest more capital in, better track, facilities, locomotives, and equipment. These physical improvements in turn incorporated new technologies and better designs that contributed to safety, fuel economy, less pollution – and further improved cash flows: a virtuous circle. Importantly, the infrastructure improvements after deregulation were achieved largely without direct federal financial assistance – and in contrast to transport operations over federally-aided highways and waterways by modes with which railroads compete.

7. The Staggers Rail Act also allowed railroads to spin-off segments of their networks to “new railroads” formed without carrying-over traditional labor contracts (which might have had “full crew” requirements or other restrictive work rules). These new “shortlines” (there were hundreds of them formed in the post-Staggers period) or “Regional Railroads” (branded collections of small carriers assembled from old or new shortlines) filled niche markets with aggressive marketing, innovative management, and new capital.

8. Deregulation also had a positive effect on railroad mergers, because it improved the prospects for the industry generally, and (in combination with enlightened oversight by the Surface Transportation Board) changed the trend of rail mergers from parallel line combinations (that reduced rail-to-rail competition) to, instead, end-to-end mergers that extended the reach of railroads into new market territories. While the impact of the new merger trends after deregulation was to continue to reduce the number of railroads and to make them larger, they also became more competitive – both with each other and vis-à-vis other modes of transport.

9. Post-Staggers mergers may have enabled railroads to achieve some economies of network efficiency through economies of size or density. An MIT team of economists led by Nan Friedlaender wrote that post-Staggers competitive economics is “nine parts deregulation and one part merger consequences.” (Cited in Gallamore and Meyer, American Railroads, p. 305.) It would be difficult to establish econometrically the shares of public benefits attributable to deregulation, mergers, or other causes, but they were a substantial feature of recent railroad economic history.

10. A particularly important development in railroad merger history was to reverse the negative impact on railroad industry structure of the Penn Central Merger (1968), which had been a key factor in the bankruptcy and collapse of Northeast Railroads. Under the “Three R” Act of 1973, these in turn led to government’s take-over of Penn Central and other Northeast railroads in reorganization, and the formation of Conrail through the U.S. Railway Association (1974-1976).

11. After expenditure of some $8 billion in reorganizing and rehabilitating Conrail, and with the help of Staggers Act reforms skillfully deployed by its new management, downsized Conrail became profitable and was privatized in an Initial Public Offering (1987). Conrail reduced its employee count by some 60 percent (from more than 80,000 in 1977 to about 30,000) by the time of the IPO. Conrail operated successfully on its own until 1999, and was then divided and sold to Norfolk Southern (58%) and CSX (42%).

12. A final positive assessment of the American experience under railroad deregulation, at least in a relative sense, is that U.S. freight railroads are enormously productive by international standards. No other railroads in the world combine the reach and profit performance of deregulated American railroads.

II. Negative Effects and Unresolved Issues

1. The Staggers Rail Act did not settle all questions regarding adequate competition for shippers and
adequate revenues for railroads. Some shippers continued to believe they were “captive” to dominant railroads that could command high rates and fail to provide adequate service; these shippers wished to continue the traditional regulatory “safety net.”

2. Relief for captive shippers might be realized by an alternative regulatory procedure called the “Stand Alone Cost” (SAC) procedure authorized by public law and administered by the transportation regulatory agency. The SAC relied on a complex and logically challenging process to review maximum rates in cases where inadequate competition had been demonstrated. The process allowed complainants to create a “hypothetical railroad,” – one designed to serve the “captive” traffic at issue; this hypothetical efficient railroad’s costs could then be used to establish a ceiling rate for the traffic. The SAC rules were designed by a brilliant group of economists associated with Princeton University (professors Baumol, Panzar and Willig); their purpose was to design a system that would determine the maximum rate any so-called “captive shipper” could be charged in a hypothetical competitive/contestable market – thus providing shippers served by only one railroad some protection from monopoly exploitation.

3. In actual practice, however, the SAC hypothetical railroad might have to rely on so-called “crossover” traffic to reach economic viability and be useable as a test case for rates. (Crossover traffic was remunerative traffic that was supposed to remain with the original carrier, i.e., was not included in the design of a minimal hypothetical railroad to serve captive traffic.) This meant that the stand-alone hypothetical costs were not a fixed and knowable standard model for determination of maximum rates, but a fungible and arbitrary artifice. As Professor Gerard McCullough of the University of Minnesota says, the difficulty always is knowing the virtually unknowable – what are the shapes of cost curves and demand elasticities?

4. A complex SAC case (of which there have been relatively few), might take many months and cost several millions of dollars to litigate. Revision of these rules to make the SAC process (or an alternative) more accessible and less costly to complaining parties is still under active consideration by lawmakers and regulatory officials. The problem is that in realizing the otherwise laudable objective of making preparation of a SAC case less costly, shortcuts might be taken that would undermine credibility of the results. Today’s rules encourage railroads and shippers to negotiate rates rather than ask the Surface Transportation Board to determine what they should be. In effect, a shipper with “captive traffic” decides whether it is better off negotiating or litigating. If the costs of litigating decrease, more cases will wind up back in the regulatory system, and if shortcuts are taken to estimate SAC costs, rates could (likely would?) move away from, rather than toward, optimality.

5. Deregulation under the Staggers Act also did not completely address the problem of sunk costs for long-lived assets that were created in the development of railroad networks, but outlived their economically useful lives. Among the most fundamental observations about railroad costs is that large capital expenditures are required to construct a new railroad and launch operations.
These initial costs are “sunk” into the railroad’s construction, infrastructure, and initial operation,
but how should they be treated in regulatory practice and deregulation theory?

6. Infrastructure sunk costs might in themselves pose a substantial barrier to the entry of a new
competitor desiring to serve the same market as an incumbent, especially if the potential entrant is
not already in a related part of the industry (and thus able to leverage its operational know-how, its
own maintenance shops, and its established access to connecting traffic). Substantial barriers to
entry might also be faced by a potential market entrant proposing to compete against incumbents
with a different technology – the possibility of a coal slurry pipeline competing against railroads
moving unit trains of coal, for example, or a firm operating driverless trucks on separated highway
lanes in competition with intermodal containerized railroad service. Clearly some major portion of
the competitive discipline for U.S. railroads comes from cross-modal rivalries (often subsidized by
the government explicitly to counter railroad pricing power). (See American Railroads, pp. 98-99). If
there are barriers to entry in cross-modal rivalry, inter-modal competition is imperfect.

7. The circumstances of large threshold costs and presumed barriers to entry had traditionally limited
market and pricing studies of railroad-to-railroad competition to consideration of “who goes
where?” and “how good are its routes?” Even normal antitrust analyses applied in other industries –
(definition of “relevant markets” with cross-elasticities of demand, investigation of product and
geographic competition, and national branding and price-maintenance [Robinson-Patman Act
strategies]) – have had relatively minor importance for railroads. Minor, that is, as compared with
the effects of traditional “ICC-style” regulation of rates and services conducted by the Interstate
Commerce Commission or Surface Transportation Board. (“ICC-style” regulation included
competitive analyses of mergers and trackage rights, and approval or not of line
abandonments and passenger train discontinuances.)

8. Only in the last three to four decades (and as a result of railroad rate deregulation
effectuated by the Staggers Rail Act) have economists broadened their microeconomic and industrial
organization analyses beyond merger studies to consider railroads’ competitive efficiency and its
impact on pricing. The new attention of economic theorists, lumped under the idea of
“contestability theory,” has turned to the question of whether or not, in the absence of ICC
regulation, markets served by railroads would be sufficiently competitive to serve the public’s
important interest in economic efficiency. Today’s railroad industry is clearly more concentrated
than it was prior to mid-century; is it still sufficiently competitive to perform well under

9. A broader and better way to phrase the question is this: In the light of both intra-modal (rail-rail)
competition, and cross-modal competitive rivalry, is the current structure of the U.S. railroad industry
workably competitive? Under what conceivable circumstances (new and larger regional or transcontinental mergers? Other circumstances?) would the industry cease to be workably competitive? Just where would we draw the line between workably competitive and not workably competitive?

10. A final unresolved regulatory issue in this list is the matter of proposals to help so-called captive
shippers by mandating reciprocal switching (or some other variant of compelled competitive
access to facilities owned and operated by a dominant railroad in the market). These proposals
generally would require that a railroad providing the only direct access to a single-served customer,
one able to demonstrate economic harm from inadequate competitive alternatives, would be
required to allow the customer to arrange competitive rail service from an independent operator
over fee-based trackage rights on the incumbent railroad. Thus, the privately-owned railroad would
be forced against its will to facilitate competition against itself. These tenant operations might
interfere with the incumbent railroad’s own service or create a safety issue due to conflicting
operations. American Railroads (p. 248) opposed compelled access as an intrusive regulatory
complexity, and possibly unconstitutional if the “host” railroad were not fully compensated.

11. Again, there is a policy dilemma. Efforts to increase intra-rail horizontal competition by mandating
compelled access could create more issues for regulatory determination. Important among these would be trying to determine what access fees should properly be charged to a new tenant rail operator, and what compensation should be made to the incumbent railroad for access to the property and to avoid an unconstitutional taking of his property.

The Bottom Line: What Staggers Act Deregulation Accomplished *

The Staggers Rail Act quite literally rescued the railroad industry from four-score years of
economic decline and set railroad finances on a path of Renaissance that has lasted for another
three decades. While the Great Recession of 2008-2009 cut deeply into the promise of the Rail
Renaissance, it did not reverse its potential completely. Also, recent experience has exposed the
industry to the fact of substantial and probably irreversible losses of coal traffic long-term, due
to the nation’s remarkable shift in sourcing fuel for generation of electricity from coal to natural
gas obtained from fracking. There remains robust growth in intermodal container traffic,
however, and other sources of rail traffic with a great deal of upside potential that would benefit
from possible improvements in railroad on-time service quality. Chemicals and agricultural
commodity movements are strong, and construction materials are poised to gain from any
increase in the nation’s infrastructure rebuilding initiatives.

The best summary description of the quantitative impact of Staggers Act deregulation of
American railroads is a graph designed by Gallamore and Meyer in the 1990s that has appeared
in many publications and which has been maintained and periodically updated for many years
by the Association of American Railroads. (A version of the graph from a few years ago is
reproduced below as a color chart.) The graph displays and contrasts annual trends in railroad
productivity, volume, revenue, and average rates over two periods – fifteen years before the
Staggers Rail Act and about twenty-five years afterward.

Screen Shot 2018-01-07 at 6.00.10 PM.png


* Economists are reluctant to ascribe causality to specific circumstances in a time series, and many or most might prefer to say that the productivity, volume, revenue, and rate trends in the post-Staggers period shown here were not exactly accomplishments of deregulation. They were outcomes for the industry, nevertheless, and they certainly help explain the impact of deregulation. (-REG)

In the period after deregulation, railroad firm productivity (measured by revenue ton-
miles of output per constant dollar value of unit input expenses) shot up to a peak of about 175 percent of the 1980 level before settling into a range easily doubling historic levels. This surge in
productivity allowed historic volumes of traffic to be handled efficiently, while average railroad
rates fell by about fifty percent. The lower rates stimulated traffic volume growth, and while
they were a reason industry revenues declined, they were an enormous benefit to shippers and
the general economy. Deregulation was clearly a win-win-win for railroads, shippers, and the GDP.

Sunk Costs and Sustainable Competition in the Economics of Railroad Transportation by Robert Gallamore

No one doubts that fixed and sunk costs in the railroad industry are as great as found anywhere in American industry.
— William B. Tye (1990, p. 86)

Among the most fundamental observations about railroad costs is that large
capital expenditures are required to construct a new railroad and launch operations.
These initial costs, sometimes called threshold costs, are “sunk” into the railroad’s
construction, infrastructure, and initial operation. They are required for obtaining a
business charter; surveying and purchasing right-of-way lands or easements; leveling
grades, bridging rivers and streams, and sometimes tunneling mountains; installing
crossties, rail, and ballast; constructing crossings, sidings, yards, and terminals;
developing train control, signaling, communications, and information systems; building
maintenance shops and general offices, and so on. In recent decades, an important
example of sunk costs for a major new project is that of preparing an environmental
impact statement (EIS) and obtaining necessary construction permits.

These infrastructure sunk costs might in themselves pose a substantial barrier to
the entry of a new competitor desiring to serve the same market, especially if such a
potential entrant is not already in a related part of the industry -- and is thus able to
leverage its operational know-how, its own maintenance shops, and its established
access to connecting traffic. Substantial barriers to entry might also be faced by a
potential market entrant proposing to compete against incumbents with a different
technology -- the possibility of a coal slurry pipeline competing against railroads moving
unit trains of coal, for example.

The circumstances of large threshold costs and presumed barriers to entry
conditioned traditional analysis of railroad-to-railroad horizontal competition in this
venerable industry, largely restricting market and pricing studies to consideration of
“who goes where?” and “how good are their routes?” Even normal antitrust analyses
applied in other industries – definition of relevant markets with cross-elasticities of
demand, investigation of product and geographic competition, and national branding
and price-maintenance (Robinson-Patman Act) strategies – have had relatively minor
importance for railroads. Minor, that is, as compared with the effects of traditional
“ICC-style” regulation of rates and services conducted by the Interstate Commerce
Commission (Surface Transportation Board after 1995); “ICC-style” regulation included
competitive analyses of mergers and trackage rights, and approval or not of line
abandonments and passenger train discontinuances.

Only in the last three to four decades (and as a result of railroad rate deregulation
effectuated by the Staggers Rail Act of 1980) have economists made major advances in
broadening microeconomic and industrial organization principles -- other than with
respect to mergers and abandonments – in application to analyses of railroads’
competitive efficiency and its impact on pricing. The new attention of economic
theorists has turned to the question of whether or not, in the absence of ICC regulation,
markets served by railroads would be sufficiently competitive to serve the public’s
important interest in economic efficiency. Further, this attention has been underscored
by the reality that the post-Staggers Act period has been characterized by a large and
funneling wave of railroad mergers – like high tides entering the Bay of Fundy. Today’s
railroad industry is clearly more concentrated than it was prior to mid-century; is it still
sufficiently competitive to perform well under deregulation?

This is the context in which the Theory of Contestability1 was developed, and in
which a rather surprising reevaluation of the timeworn notion of sunk costs has come
about. The reevaluation has produced some interesting wrinkles that are relevant in the
modern railroad context.

Railroad Networks, Sunk Costs, and Contestability

What do we mean by “barriers to entry,” “fixed costs,” and “sunk costs?” As
pointed out by consultant William B. Tye, some of the best ideas come from (without
fully coinciding with) the Chicago School of economics and the theory of contestability.
By “contestability” was meant dynamic conditions in an industry with single– or
multi-product firms normally realizing increasing returns to scale, such that market
power was present in sufficient amount to enable firms to earn adequate revenues.
Such combinations would permit the firm to remain viable (cover average total costs),
while rates were constrained to reasonable levels by credible threats of competitive entry
into the relevant market. “Captive shippers” (those not benefiting from adequate
competition) expected to see their rates capped by application of the Staggers Rail Act’s
Stand Alone Cost (SAC) test to levels a hypothetical dedicated, efficient, new market
entrant would charge. In fact, the ICC ruled in its Coal Rate Guidelines decision that
railroads are not sufficiently contestable overall, but that the SAC test could simulate
contestable market conditions in captive shipper cases.

Of course such a tightrope walk was controversial and gave rise to more than the
usual amount of learned academic discussion (lay people might characterize it
differently) -- as well as further regulatory hand-wringing. Captive shippers were not
satisfied that the Staggers Rail Act’s protections against their exploitation had been
honored adequately, and continued to seek legislative relief. But both deregulation of
rates and services and mergers tamed with competitive conditions could go forward,
and they did. More extreme remedies, such as competitive access compelled by regulatory
authorities to lower entry barriers (by reducing the sunk cost risks of entry and exit), or
nationalization and subsidy of bankrupt railroads, were not approved.

It is true that investments in railroad networks (as described above) are sunk.
They cannot be moved easily to other locations (time and place utility is everything in
transportation – see Box 2.3 in Gallamore and Meyer, American Railroads), and thus these
fixed and sunk costs have limited alternative-use value. This also means that network
operation is definitely not “perfectly contestable.” But service operation is a different
kettle of fish, since rolling stock and motive power can be redeployed, at least to some
extent. Also, since passage of the Staggers Rail Act of 1980, railroads have become
extraordinarily successful in developing intermodal (highway/rail) services in both
domestic and international transportation. These are based on unit trains of double-
stacked containers operating over railroads between major terminals (“ramp-to-ramp”),
and on public highways or waterways beyond. Intermodal services, because they
typically use road transport for origin and destination connections to extend railroad-
managed services off the fixed track networks, have liberated rail markets from some of
their former rigidity.

These are risks an incumbent railroad faces, but the risks are even more clear and
present for a new entrant. All those recent costs sunk in new construction and
competitive start-up are at risk and would have to be swallowed if a failed entrant must
later give up on the enterprise and exit the market. Thus, sunk costs are a large
impediment to new competition in the relevant market.
Next comes the issue of barriers to exit as well as entry. Taking what might be
assumed to be the usual case, incumbent firms have served their markets and
communities reasonably well. They have hired employees, given local shippers
opportunities to participate in distant markets, and provided ancillary businesses
locational advantages. They want to stay in that market as long as they can, but if any
combination of external circumstances and new competition makes an incumbent
railroad’s business unprofitable, it may try new pricing initiatives and may even have a
going-out-of-business sale. Ignoring the sunk costs of original investments, the railroad
may revert to out-of-pocket (short term variable cost) pricing for survival – any traffic it
can continue to attract will help pay the bills. These lower prices increase barriers to
entry, but may or may not injure overall social welfare, depending on the viability of
incumbent firms and their efficiency in serving the market.

If pricing remedies fail, an incumbent railroad may apply to abandon the line,
look for a merger partner, or even seek bankruptcy protection of its remaining assets.
Bowing to public pressure to preserve service and jobs, the regulatory authority may
disallow abandonment – increasing the costs of exit. (For American railroads in the
1960s and 1970s, this was the case for tens of thousands of miles of little used lines -- and
for hundreds of deficit-producing passenger trains.) The cost of exit for passenger
service, for example, could be tallied up by counting years of delay in discontinuing
deficit trains and by the initial outlays and ongoing opportunity costs of turning over
services to Amtrak after its establishment in 1971. (See Chapter 11 of American Railroads.)
In the rail world, the full import of sunk cost theory would have applied only to
network operations. It would not have applied to operation of “foreign” trains on
trackage rights (a formal agreement qualifying a tenant operator to use an owner
railroad’s facilities on a fee for service basis), or to flexible intermodal services. Nor
would it have applied to much of the remainder of network operations if the statutes
and regulators had been willing to structure an alternative competitive universe; this
hypothetical could have resulted from a requirement that incumbent railroads submit
to compelled open access -- the use by a competitor of a privately owned railroad’s
track and structures under a regulatory mandate for the express purpose of breaking an
incumbent’s monopoly power over prices. (See American Railroads, Chapter 9.)

Now economists had to ask if, under these circumstances -- that is, after passage
of the Staggers Act and the rise of competitive modes (e.g. larger combination trucks on
the Interstates) and efficient modalities (e.g. double-stack containerized intermodal
service) -- rail markets had become sufficiently contestable to relax the old constraints of
adversarial ICC rate and service regulation and to allow a transition to deregulation.

Barriers to Entry and Exit of Competitors

In contestability theory, sunk costs count as a barrier to entry. There are several
ways to think about why this is so. Economists, including Baumol and others often
associated with the Chicago School, emphasized that the need to incur large costs to enter a
market is not itself a barrier to entry, as long as incumbents do not have large cost advantages
over new entrants. But where sunk costs create cost advantages to incumbents, they may
be thought of as a barrier to competitive entry. In the Chicago School’s perspective,
incumbents have already incurred sunk costs, but potential entrants have not yet done
so. If newcomer firms can enter an industry on the same terms as incumbents, after
entry they can compete on equal terms and merely replicate whatever functions
incumbents had carried out before.

A railroad industry example of potential entry with large sunk costs might be the
cost of assembling a contiguous right-of-way for a pioneering transcontinental railroad.
More contemporaneously, the Dakota, Minnesota & Eastern Railroad sought permission
to construct a new rail line into the Powder River Basin (American Railroads, Chapter 10,
Box 10.3) enabling its entry as a third competitor for eastward movement of low-sulfur
coal; while the line is not yet built and its future is unclear, clearly the proposal
illustrated sunk cost entry barriers.

There are other ways in which sunk costs of railroad establishment and
operation might not prevent new market entry – new competition that could challenge
a monopolist’s power to restrict output and realize rents. For example, if the potential
entrant is well capitalized, it might be able to afford to build or buy infrastructure
facilities comparable to the incumbent’s. If the market is large and demand is booming,
there may be room in the market to support an efficient new competitor that will be
able to price at levels covering average costs – uninhibited by an incumbent’s implicit
threat of predatory pricing. That is, if the market is big enough to support several
competing regional networks -- the sunkness of investment costs may not do much to
keep competing networks from emerging. In this case, market size is everything.
If the market is small, however, the incumbent may have substantial existing
advantages making it costly or economically impossible for the new entrant to get a
foothold in the business. Indeed, there may be no more available routes over which a
competitive line could be built. Or regulatory authorities may believe there is
insufficient potential traffic for two railroads in the market -- fearing, for example, that
one or both competitors may be unable to cover fixed charges stemming from the new
entry or its impact, and thus stranding investments. In such a case, the regulatory
authority may be unwilling to grant a construction charter or certificate of convenience
and necessity to the potential entrant.

There is another line of thinking that leads to similar conclusions. Even without
regulatory intervention, the incumbent may have significantly declining costs with
greater volume, and thus, as a natural monopoly, may be able to set and sustain prices
lower than any challenger could. Sunk costs also might create opportunities for
incumbents to punish new entrants by cutting prices. In contravention of antitrust and
regulatory law, an incumbent might use predatory practices to thwart a newcomer,
deliberately lowering prices in the near term to discourage entry, then returning them
to monopoly levels when the threat of new competition is gone. With necessarily sunk
costs for any industry participants, incumbents can tailor prices to their advantage
faster than entrants can exit the market. Thus, if there is a risk to incumbents that new
rivals might upset their profit-maximizing pricing, there is even more risk to the
potential entrant, namely that perceived prevailing prices ex-ante might melt away ex-

As pointed out by specifically by Professor John H. Brown of Georgia Southern
University, the real impact of sunk costs is that incumbents cannot recover their sunk
costs if they exit the market, and therefore only incremental costs matter in their
decision-making. Saudi Arabia might say (and mean) that it is cutting prices to punish
new entrants to world oil markets that are using fracking technology to recover crude oil
from tight reserves. As has been said, no cost is quite as sunk as a hole in the ground!
Further, imagine a different kind of case in which a single incumbent in a market
has no sunk costs to recover in subsequent product pricing, and can therefore exit the
market at no cost. According to contestability logic, nevertheless, the incumbent cannot
earn monopoly profits -- because if it tries to do so, potential entrants also with no sunk
costs can engage in “hit and run” entry. By definition, this means that the new entrant
can undercut the incumbent’s price and erode its market position. While rare in the
U.S., an example might be a case in which a commuter authority franchises operators to
provide service using the authority’s track and rolling stock; these contract operators
can come and go at the authority’s bidding without the need to sink costs on entry or
recover them on exit, because these are provided by the commuter authority. Still, the
contract operator might be in competition with another incumbent, such as Amtrak.

In sum, sunk costs are important in the microeconomic theory of competitive
ratemaking. These are what prevent natural monopoly or natural oligopoly markets
from being perfectly contestable. Violations of perfect contestability conditions
through the presence of sunk costs become a barrier to new entry, enabling incumbents
(again in theory), to set prices that are above marginal and average costs. Likewise,
sunk costs are also a barrier to exit from the industry, because they cannot be amortized
by moving assets to another market. Similarly, there is no salvage value in the assets
that the firm might recover or take with it in exiting the industry. Consequently,
according to the theory, the villain is sunk costs -- those that cannot be recovered by
exiting the market.

- # # # -

When students were studying economics in the 1960s, most all were told that
truly sunk costs could safely be ignored, because “bygones are bygones” and what
matters are investments going forward. That old learning may have subconsciously
guided me to leaving the discussion just presented out of American Railroads; I quite
literally “ignored” sunk costs. Like the railroads, so often “out of sight and out of
mind” but now hailed as an engine of economic growth and productivity, it is a bit
strange that the concept of sunk costs has moved from irrelevance to center stage in
important contemporary theories of the economics of transportation!

Where Are Railroads on the Cost Curve?

Critical to the theory of contestability and the preceding illustrations is the
assumption that incumbent railroads are operating at less than minimum efficient
scale. This means that each firm is producing on a declining portion of its average total
cost curve, as illustrated in Figure 1 [at page 20 infra]. It currently has declining
incremental costs with volume (scale of operations) and, necessarily, excess capacity.
The firm would benefit from increased demand, which would enable improved
utilization of its assets. Further, due to technical indivisibilities, or “lumpiness” (in
that the value of each unit output of the product is large relative to the size of the
relevant market), some of both incumbent’s and potential entrants’ costs are fixed over
output but not sunk over time. Think of a contractor who builds a few houses in the
space of a year, but has working capital tied up in inventory until those units are
finished and sold – or perhaps a rail line renewal project that takes two construction
seasons to complete and cut into service.

By contrast, perfect contestability is not violated by the actuality of fixed costs,
because these are simply cost indivisibilities trapped by the incumbent being forced to
operate at less than minimum efficient scale and therefore being forced to endure (and
absorb the costs of) excess capacity. For example, our illustrative building contractor
has one-half of a house left incomplete and unsold at the end of a season; he might have
avoided this inefficiency if higher demand had permitted scaling his operation that
season to a larger and evenly divisible output. Similarly, the rail renewal project might
have been completed in one season if more and larger equipment were brought to the
site and put to work – which in turn might have been cost-effective if the project were
planned for multiple tracks or longer track segments.

The importance of the cost issues addressed in this paper and illustrated in
Figure 1 (and the policy consequences that go with them), has everything to do with
where experts believe railroads are on the U-shaped curves. For years, students of
railroads have assumed that railroads operated on the left side of the chart, that they
were natural monopolies, that they had declining costs with scale, that marginal cost
pricing would bankrupt them, that value-of-service (VOS) pricing would be the manner
in which firms could afford to stay in business and fulfill their common carrier
obligation to serve all comers, and lastly, that only price differentiation could bring
revenue adequacy. John Meyer warned that just as ICC-imposed railroad VOS
ratemaking in the early decades of the twentieth century drove business to competing
modes (American Railroads, Chapter 2, p. 28 ff.), differentiated inverse-elasticity pricing
could do the same -- unless marketing officers are very skillful and have good
information on which to base their pricing decisions.

In contrast to the well-known history, recent experience in the industry gives
many indications that railroad firms and their markets have moved to the right side of
Figure 1. Here railroads need not try so hard to expand traffic, as to ensure that services
are priced to earn adequate revenues, win contract rate competitions with rates and
service quality that will perpetuate participation of customers in the market, and plan
capacity expansions to handle volume increases with better service.

The pricing paradigm that permits these things is not Ramsey inverse-elasticity
pricing, really, but Vickrey congestion pricing -- use of demand-based prices to ration
available capacity to the users most willing to pay for it. These are still differentiated
prices, but they have a different rational and perhaps a greater need for quick and
flexible application. The example provided in American Railroads is a set of trackage fees
private freight railroads might optimally receive from public passenger service agencies
for operation of their trains over (congested) freight infrastructure. Ideally, the Vickrey
congestion-based fees would be the same as prices based on opportunity costs, but
calling the trackage fees by that name is unpopular – perhaps it sounds too exploitative.
Meanwhile the public is getting more and more used to the idea – and the necessity --of
congestion tolls, so perhaps that is a better appellation than the economist’s term,
opportunity costs.

Thus is the complexity of railroad costs – sunk and fixed, declining with output
or rising with constrained capacity, and optimally priced only when demand elasticities
and their location on the U-shaped cost curves are properly estimated. These must
guide government and industry policy. Revision of received wisdom to fit these newly
understood circumstances is a necessary endeavor.

Contestability and Railroad Mergers

The previous discussion follows from and fits naturally with the dilemma of
railroad mergers described in American Railroads, including the historical policy debates
over the welfare advantages of industry consolidation vs. competition in relevant
markets. In the last few decades of the twentieth century, academic and regulatory
economists began to address the dilemma as a contest between the social virtues of
deregulation, on the one hand, in contrast to continuation of the drive for economies of
scale and scope, on the other. Depending on many circumstances, merger economies
presumably were available from either horizontal (parallel – “cost-saving”) or vertical
(end-to-end – “single-line service”) combinations. With jobs and competitive service
always at risk in parallel consolidations, end-to-end merger into a railroad reaching new
markets might be seen as the most palatable restructuring alternative from the
perspective of either the incumbent railroad or the regulatory authority. Williamson’s
Lemma, we called it in American Railroads.

Having passed through the enormous financial and personal costs, dislocations,
and uncertainties of the “Northeast Rail Crisis” (American Railroads, Chapters 6 and 7),
many observers hoped that the new theory of contestability would enable and
encourage regulators to approve both beneficial railroad mergers and deregulation. If
successfully executed, these would together free railroad managements from the
artificial and resource-distorting economic costs of traditional ICC regulation – as well as
serve the longstanding but unproven belief that railroads should be consolidated into
fewer, larger, and more streamlined firms.

Meyer and Tye on Contestability and the Transition to Deregulation

In the 1980s, John R. Meyer (1927-2009) and William B. Tye jointly authored an
important article on the applicability of sunk costs and contestability theory to railroad
deregulation in the latter part of the Twentieth Century.
be summarized as follows:

Under regulation, both railroads and their shippers sink costs in their respective
parts of the transport enterprise, but ICC regulation quite unnaturally outlawed normal
business-to-business contracts (see American Railroads, Box 9.2). If allowable, these
contracts would have protected subject businesses from random or opportunistic
behavior harmful to efficient rail service.

Tye recalls that his co-author Meyer viewed the presence of sunk costs as the
primary threat to a successful transition to deregulation, and he foresaw the need to
develop transition mechanisms. Under railroad regulation, both carriers and shippers
sank costs in their respective industries, but ICC regulation displaced the usual business
contracts existing in other industries to protect the parties from opportunistic behavior
that would otherwise be possible. Anticipating that law and policy would allow
loosening of the ICC’s grip on railroads, Meyer and Tye nonetheless were concerned
that simply going “cold turkey” from regulation would fail to account for the fact that
there is a legacy of carrier and shipper sunk costs from the prior regulatory regime.
(John Meyer called the phenomenon “regulatory overhang.”)6 At the same time, Meyer
and Tye reasoned, abrupt deregulation would not convey the contractual protections
that would have been in place in other capital-intensive and publicly beneficial
businesses before sinking costs.

The primary objective during a transition to deregulation, the two economists
argued, is to develop safeguards against rogue opportunism (misbehaving while the
teacher’s attention is diverted), but nonetheless to encourage switching from traditional
rate and service regulation to contract ratemaking as permitted by the Staggers Rail Act
of 1980. Importantly, the new contracts that ought to be put in place should take the
form of normal business contracts that would have been signed prior to the parties
sinking costs, (not spot contracts that were more likely under the legacy of sunk costs
from the prior regulatory regime).

To repeat, Meyer and Tye urged that railroad-shipper ratemaking agreements in
the transition to deregulation should mimic arrangements that would have been signed
in the absence of sunk costs. The proposed contracts would look like the kind
businesses would have put in place had they been signed prior to sinking costs.
Sponsorship and funding of airports is a particularly interesting application of the
“contract–before–sinking costs” model. Perhaps another useful analogy would be the
counterfactual outcome resulting if, in agreement with the British Parliament, the
American Colonials had imposed modest tea import taxes on themselves rather than
suffering from, and having to rebel against, King George’s imprudent levies.
Deregulation was like overthrowing colonialism; it would necessarily be disruptive, but
it needn’t lead to casting valuable tea overboard followed by armed rebellion -- and
certainly not the French Revolution’s Reign of Terror.

What Would John Meyer Say Today?

I learned from John Meyer that virtually all businesses, large and small, have
some market power, or they would be unable to survive. Economies of scale in
transportation businesses like pipelines, railroads, and airlines are part of their nature,
but could not by themselves create and sustain substantial market power; rather, the
industry and the firm needed durable, relationship-specific capital investments as well,
and these assets would be both large and sunk.

Professor Meyer illustrated this observation with discussion of airline economics.
Airlines enjoy pronounced economies of scale in aircraft size, and these indivisibilities
alone might constitute a barrier to entry allowing incumbents to profit from charging
rates above marginal costs. Still, planes are mobile and not sunk in specific markets, so
the threat of “hit and run” entry competition is credible. Like the important
observations made earlier regarding portable (not sunk) railroad operating equipment
such as locomotives and freight cars versus network sunk assets, contestability theory
applied to aviation became part of the justification for airline deregulation.

Such circumstances would be true for railroads as well as airlines if they were
organized along the European model of vertical separation – i.e. public ownership of
rail track and facilities, with franchised, above-the-rail operating companies competing
for deregulated traffic. Thus, one can imagine a regime, not unlike that in the
privatization of British railways, where (subject to price, access, and service regulation)
policy has granted to a named monopoly franchise long term responsibility for the
national publicly-owned railroad infrastructure (Network Rail), but permits and
facilitates competition among various franchised freight and passenger operators -- all
of whom pay fees for licensed access to operate over portions of Network Rail.

John Meyer was quick to point out, however, that this vertical separation
(“above-the-rail” versus “below-the-rail”) model for railroads has many other problems,
including the difficulty of making optimal trade-offs between capital improvements and
operating expenses; these are such as for maintenance of way, coordination of train
operations with track maintenance and renewal activities, setting dispatching priorities
among users, determining correct cost allocation and levels of user fees, and lastly the
fact that public ownership of infrastructure can perhaps too easily be used as a vehicle
for subsidy of operations. As noted in American Railroads, similar issues continue to
complicate American railroad economics in the one key area in which it relies on vertical
separation: long distance Amtrak passenger service outside the Northeast Corridor (this
on track owned by private profitmaking firms, not public infrastructure agencies).

From the point of view of practical railroaders, the academic arguments presented
in this paper were all much ado about very little, but the implications for policy toward
mergers and competitive access were real and worrying. Railroaders had seen cost
structures in their businesses change quite radically even before deregulation. Variable
costs were increasing as a share of total costs (sunk costs were being depreciated away or
written off), and the old ICC cost formulas such as Rail Form A had become hopelessly
obsolete. The ICC’s preoccupation with such things as setting divisions for interline
rates, prescription of car hire (per diem) rates, and productivity adjustments to the
prevailing inflation-adjusted railway charge-out price and cost indexes, were held in
contempt by the railroads – and were fast fading in relevance.

What railroads needed were adequate revenues, which before the turn of the
Millennium, they rightly believed might be achievable with Ramsey pricing and
differential rates, even if perfect contestability conditions had to be relaxed. Indeed,
William Tye, citing the historic dispute between Pigou and Taussig over whether
revenue adequacy and intramodal rail-rail competition are mutually exclusive (“the
oldest regulatory debate in the railroad industry” [Tye, 1990, p. 94]), wrote that markets
become unsustainable as circumstances move toward perfect contestability, and that
Ramsey pricing and perfect contestability are diametrically opposed concepts. In the
new Century, however, railroads have in fact been able to get their rates up to “revenue
adequate” levels for the most part, and traffic is filling up most excess capacity; the large
railroads are now investing unprecedented amounts in annual capital spending to
increase capacity.

All of this says that the times, they are a-changing. It is an important lesson to be
learned from study of an industry with sunk costs, but also one with historically
changing cost patterns and demand characteristics. This observation brings me back to a
reconsideration of John Meyer’s skepticism regarding extreme price discrimination as a
key answer to the rail industry’s problems. His objections arose chiefly from the strong
incentives that differentiated prices would create for adversely affected shippers to find
alternatives. It is now quite apparent that changes in the market for coal as a fuel for
power generation are resulting from inroads made by natural gas generation, plus
anticipated coal plant retirements due to cost and environmental concerns. These are
evidence of contestabilities quite literally replacing captivity. While declining coal traffic
volumes seem to have been cushioned by increasing rail traffic generated by fracking
and growth of other commodities as well as intermodal containers, John Meyer’s
concerns regarding coal traffic seem to be coming to pass.

Meanwhile, as detailed in American Railroads, the rail renaissance has continued.
Since the turning of the Millennium and especially since the end of the Great Recession,
large mergers overcame their teething problems, safety indices have been improving,
operating ratios showed efficiency gains, and new investments were adding to industry
capacity. Shippers were receiving lower rates overall, short lines were prospering,
employees were getting higher compensation, and no one was concerned about line
abandonments. With larger volumes of traffic moving under long term contracts having
inflation adjustment clauses, railroads saw competition for renewal of these contracts as
much more important than discussions of sunk or avoidable costs for marginal
businesses. How could anyone be thinking about reregulation when the Staggers Rail
Act was working so well?

In these remarkable ways, American public policy toward competition and
contestability in rail markets had reached a fairly stable equilibrium by the early years of
the new Millennium. How long it will endure remains to be seen.

American Railroads: Decline and Renaissance in the Twentieth Century by Robert Gallamore

Click to view on Amazon.com

Click to view on Amazon.com

My new book with distinguished economist John R. Meyer (1927-2009) was released in June, 2014. It is a comprehensive history and analysis of the American Railroad industry throughout the last century.  It covers the initial years of regulation by the Interstate Commerce Commission, antitrust prosecution of the James J. Hill and E. H. Harriman empires, Federal control of railroads during World War I, and the efforts to consolidate railroads into fewer and larger systems in the 1920s.  Other adaptations were forced by the rise of rival modes of transportation, barges on inland waterways, Federal and state support for hard surface roads to "get the farmers out of the mud," and several kinds of assistance to the infant aviation industry -- development of military aircraft, Federal air mail contracts, management of the airways and air traffic control system, and metropolitan governments' construction and operation of airports.

World War II brought high traffic levels to the railroads, both passengers and freight, but what should have been a blessing was not.  Rates were held down to fight inflation, production controls kept railroads from renewing their fleets of locomotives and passenger cars, and the heavy traffic wore down track and equipment while windows for maintenance work were hard to find.  After the war, pent-up demand for consumer goods and housing triggered a great migration of industry and population south and west.  Returning servicemen wanted to go to school on the GI Bill, buy a new house and car, and settle in the suburbs.  Those new automobiles created some demand for rail freight, but drew passengers away from the rails; and demand for dual, limited access highways led to establishment of the Interstate Highway System. Trucking firms, initially owner-operators hauling agricultural goods exempt from regulation, and later long-haul truckload carriers operating in a deregulated environment, developed highly efficient and reliable networks, and took the cream of manufacturing traffic from the railroads.

Economic conditions deteriorated further in the 1970s.  The ICC kept its firm hold on railroad rates and services, despite inflation.  Approval of the Penn Central merger sharply limited competition in the Northeast, but it was an ill-starred match, and within a year and a half PC was bankrupt, dragging down a half-dozen other railroads with it.  Congress intervened in the 3R Act to establish a process for reorganizing service, abandoning many light density lines, setting up Conrail, funding rehabilitation of key lines and facilities, and paying the bankrupt Northeastern estates for their property conveyed to Conrail.  The newly federalized railroad continued to lose cash at the rate of about a million dollars a day, however, and it became evident that more lines would have to be dropped, more employees laid off, and commuter and Amtrak services would have to be transferred away from Conrail.  Most important of all, the old ICC regulatory system would have to be abolished and replaced with contracts negotiated between railroads and shippers, so that they could allow services and rates to be based on the fundamental laws of supply and demand.  This genuine reform -- after a series of half-hearted half-steps was finally accomplished in the Staggers Rail Act of 1980.

It is remarkable that the sweeping remedy of deregulation in the Staggers Act was in fact adopted, and that it worked better than almost anyone forecast.  Today the railroad industry has risen like Phoenix.  In 2000, US railroads generated more than ten times as many ton-miles annually as they had in 1900, with only 16.5 percent as many employees.  Under deregulation, rates have been cut in half, because railroads are more efficient and their employees and facilities are more productive. Technological advances have been built into nearly all aspects of industry operations, and the new facilities and operating methods have proven far safer. Fatalities and injuries continue their long-term decline since deregulation.  American Railroads details the legislative history of regulatory reform, explains its economic roots in economic theory, and defends deregulation against efforts by so-called "captive shippers" to re-regulate rail rates and services.

Implications of the Panama Canal Widening Project for North American Container Ports by Robert Gallamore

Photo: sjrankin on Flickr

Photo: sjrankin on Flickr

     This is an essay about a transport investment expected to have world-wide and long-lasting implications.  I have never seen the Panama Canal, but its fascination for me began with an old-fashioned book in my father’s library, called The Story of the Panama Canal, or similar, and dating to the period of the Canal’s construction almost a century ago.  Then David McCullough’s magnificent Path Between the Seas (1977)  told us all so much more than we had known before.  In the Cold War era there were proposals within the “Atoms for Peace” program to use nuclear devices to blast a new sea-level canal; that fantasy, fortunately, had “no legs” – to mix the metaphor something awful.  Later, President Carter’s farsighted – but at the time widely maligned – proposal to return control of the Canal Zone to the Panamanian Government was enacted by Congress, and implemented on schedule in 1999.  Shortly thereafter the Panama Canal Authority was established and plans to widen the original facility were made.  Congestion in transiting the canal had become an issue of considerable concern to commercial users, and what is more, the Canal’s original gravity system for raising and lowering vessels through its locks using fresh water from Lake Gatun, was no longer environmentally sustainable for the long run. 

Figure 1.  Panama Canal Competittors.  Illustration Courtesy of Georgia Ports

     Now the Canal is being widened to handle ships with more than two and a half times the container carrying capacity of today’s Panamax vessels (those that can just squeeze through the current locks) (See Figure 1).  The Authority wisely chose a strategy to widen and deepen the canal, but re-cycle much of the lock water rather than wastefully letting it all flow out to sea.  Disbelievers in the economics of the widening project (including at one time this writer) have slowly melted away; there may be delays in construction, but completion is assured and the targeted opening date is delayed only one year, to 2015.  What are the implications for North American container ports and their connecting double stack railways?  That is the subject of this essay.

Figure 2.  Dimensions Slated for Widening and deepening of the Panama Canal

     World-wide shipping economics and operations changed quite dramatically in the post-World War II period, to make the Canal widening project not only feasible but commercially warranted.  Perhaps most important was the innovation by trucking and shipping entrepreneur Malcolm McLean of the marine container, which revolutionized ocean shipping.  McLean demonstrated his idea by outfitting one of his ships, the Ideal X, to carry highway trailers on an open deck.  The initial voyage was from Newark to Houston, carrying 56 trailers.  Before long the manifest savings in ship loading labor, wharfage space, pilferage, and damage to goods warranted expansion of the network to include a fleet of specialized ships and their containers – boxes sans wheels.  Among other benefits, containerization meant ships carrying mixed manufactures could be much larger, because they were unloaded faster and the containers could be stacked several high and/or quickly moved away from the wharf on chassis. 

     Next came the idea, implemented first by Southern Pacific Railroad and SeaLand, of stacking containers two-high on railroad flatcars.  Aside from the obvious savings in train length and flat car platforms, the double-stack (DST) configuration had superior wind resistance properties compared with the alternative, truck trailers on flat cars (TOFC).  Affixing the top container to the lower unit or platform of the flatcar took a bit of ingenuity, but it turned out that the standard method used onboard the new generation of containerships, an interbox connector (IBC) with proper end-post fittings on the container itself would suffice.  Once double-stack train economics became available, containership operators saw the opportunity to provide direct service from Asian ports to US West Coast docks for rail intermodal shipment inland or even transcontinentally. 

     These services would not have been economically feasible without a corresponding innovation, long term confidential contracts between maritime carrier customers and their partner railroads; these long-term contracts were only newly legalized by the Staggers Rail Act of 1980.  The international containership operators soon acquired fleets of “Post-Panamax” vessels – unable to transit the Canal – and thus dependent on the success of double-stack trains.  As with all market economics, however, there is no “free lunch” -- nothing fixed about trade-offs among competitive alternatives.  The very success of the Asian – American containership liner trade with Post-Panamax vessels carried with it the seeds of renewed interest in widening the Canal.

     The recent sharp drop-off in international intermodal loadings from West Coast ports during the Great Recession, almost one-fourth of the traffic, caused some ports to request that their railroad connections re-examine rate structures in order to hold the line against diversions to Panama Canal routings.  But as pointed out by veteran intermodal marketing executive and commentator Theodore Prince, the railway rates are market-based.  Prince goes on to note that we are seeing only the initial salvo in port – railway pricing controversies related to mini-landbridge vs. Panama Canal routings with completion of the new Panama locks.  Industry leaders disagree on the extent of diversions, he says, some believing markets as far inland as Chicago, St. Louis, and Dallas will be reached westbound from the Atlantic, while others expect West Coast ports not to lose share to Canal routings if inland penetration would require “reverse” rail flows exceeding 200 miles. 


Round-the-World (RTW) and North American "True Landbridge" Options

Figure 3. Alternative Routes Singapore to New York.  Map courtesy of Prof John Hudson, Northwestern University

     Before moving to a discussion of implications of the New Panama Canal for North American ports and double-stack services, a few comments on RTW and Landbridge services seem appropriate, as they will also be affected by widening of the Canal. 

     Malcolm McLean’s round-the-world (RTW) services were based on the then-Panamax EconoShip of a special design maximizing container capacity at the expense of fuel economy. "Panamax" meant vessels that were just barely able to squeeze through the Canal; they were boxy – not sculpted for fuel efficiency. (Now we need a new word for vessels barely able to transit the widened and deepened Canal -- I'm suggesting "New Generation Panamax" so as not to be confused with earlier use of the term "Post-Panamax." 

     Later developments in round-the-world shipping, particularly by Evergreen, showed that McLean had chosen the wrong direction for transiting the Panama and Suez Canals. McLean had dispatched RTW EconoShips eastbound through Panama and Suez. Halifax, for example, worked better in the eastbound direction, so that Asian goods would come to Canada via Halifax and then go on across the Atlantic to Rotterdam. Inspection of the map (Figure 3) shows, however, that the Suez route is considerably shorter for traffic from Singapore to Rotterdam via Suez, and competitive even if the origin moves to Japan, (or if trans-circumnavigation of Africa via the Cape of Good Hope were necessary because of trouble at Suez).

North American Landbridge

     Extension of North American mini-landbridge services to serve the true landbridge route between Asia and Europe has never reached maturity.  Originally advanced when the Middle East conflict (Yom Kippur War) closed the Suez Canal in 1973, the logistics advantages of the true landbridge could save perhaps two sailing days from Tokyo to Rotterdam by taking advantage of fast DST service across the USA or Canada and avoiding congestion delays at Panama or Suez on the long trip around Africa.

     Widening and deepening of the Panama Canal probably would end any further consideration of North American true landbridge service.  While the two or so day savings from the DST land transit would still be available, congestion at Panama (and any possible related overflow back-up at Suez from liner traffic using that route to avoid Panama would no longer be relevant considerations.  Also, improvements to routes inland from U.S. ports are not likely to benefit from landbridge services, because diversion from West to East mini-landbridge would draw investment dollars away from that route and toward South to North flows over Gulf Ports and East to West flows from the Atlantic ports to the American Midwest.  One possible benefit for true landbridge could come from port improvement at, say, Savannah, Charleston, or Hampton Roads and use of other DST lanes improved for other purposes; as noted above, these include the Sunset Corridor to El Paso, the T&P route from El Paso to Dallas-Ft. Worth, UP routes to Memphis or Shreveport, the Meridian Speedway, and NS corridor improvements to the Crescent and Heartland corridors.

     Finally, there is the issue of Suez routings to the East Coast.  It was the case only a few years ago that Singapore was the rough breaking point between traffic flowing east (Panama or mini-landbridge) or west (Suez) to New York.  Now that “watershed” point appears to have moved west to India or even further, some say. 

 Implications of Widening the Panama Canal for North American Ports and Double-stack Operations:  Will the Containers Move East from the Pacific, North from the Gulf, or West from the Atlantic?

     The discussion that follows provides a qualitative assessment of changes in double-stack flows likely to come about as a result of the completed widening of the Panama Canal.  The largest ports and their railroad connections will be affected most; the Top Ten U.S ports are show in Figure 4 below.  To these we have added a few other U.S. ports, several Canadian ports, and a brief discussion of impacts on Mexico locations.


Figure 4. Top Ten US Container ports.  Chart Courtesy of Georgia Ports.

     American port cities along the Gulf of Mexico and Atlantic Ocean – from Houston to the port of New York/New Jersey – anticipate large increases in their handling of mixed freight – miscellaneous merchandise and manufactured goods arriving by containership.  Implications for bulk cargoes carriers and military vessels are not expected to be as significant.

     There are two implications of the canal-widening for handling of international containers drawing the greatest amount of discussion.  One is, which American ports will be winners and which losers?  The second is, what changes will occur inland in flows of containers divested from existing lanes to new Panama Canal routings. 

     The first of these two discussions is mainly about which Gulf and Atlantic Ports will be able to expand fastest and most economically to handle the anticipated growth?  The second issue then relates to the fallout:  How far inland will container flows penetrate by double-stack container trains from the Gulf and Atlantic ports?  What will be the impact on existing and forecast mini-landbridge double-stack movements from West Coast ports to mid-continent gateways and on to mega-consumption regions in the East and Southeast?  Will massive development of facilities to serve these flows (West Coast ports themselves – Los Angeles, Long Beach, Seattle/Tacoma, Oakland, etc.) transcontinental rail lines (BNSF, UP, NS, CSX); and Mississippi gateway inland ports (Chicago, St. Louis, Memphis)?  Will these existing investments prove to have been premature?  (Unlikely.)  Will the new Panama Canal route competition turn out to be exaggerated?  (Somewhat, but not entirely.)  Or, perhaps a third outcome – some combination of these influences – will result.

     Our conclusion is that the third outcome is most likely.  Gulf and Atlantic port growth will be huge, but not all of it at the expense of Pacific ports.  This view anticipates the effect that growth of Pacific ports and mini-landbridge container traffic is just slowed, not put into a tailspin – and that could turn into a good thing.  A collateral development associated with this third line of reasoning is that some land-side resources that have been devoted to creating capacity for handling international container movements over Pacific Ports and mini-landbridge gateways will be “redeployed” to servicing the continuing strong growth of domestic container operations. BNSF’s completion of its multi-year double-tracking and de-bottlenecking of the former Santa Fe's Transcon” line, Union Pacific’s large investment in double-tracking the sunset corridor from El Paso west to Colton, California.  Norfolk Southern’s Crescent Corridor improvement from Harrisburg to Memphis, Kansas City Southern’s “Meridian Speedway,” Chicago area intermodal improvements at the Joliet Arsenal site (BNSF and UP) and at Rochelle, Illinois (UP).  The Los Angeles area’s Alameda Corridor East plans – all of these may continue to be built out perhaps at a slower pace – but with acknowledgment that their purpose in life is more to serve domestic containerization than their original raison d’être – international double-stack containerization.

     To return to the topic that launched these thousand ships of thoughts, what can be said at this point about impacts on Gulf and Atlantic Ports from Panama Canal widening?  Let's go down the list, counter-clockwise, port by port, arbitrarily starting at Houston.


     Among America’s largest ports based on bulk traffic (crude oil and petroleum products), the Port of Houston stands to be a winner in the new post-Panamax stakes.  Houston is on the shortest distance path from the Panama Canal’s Caribbean/Gulf/Atlantic outlet to the American Midwest.  As shown on the accompanying map (Figure 4), Houston’s “rail shed” would encompass Chicago, St. Louis, Kansas City, and all of Oklahoma and Texas.

     Depending on port expansion on the Gulf Coast of Mexico, Houston might also participate in Mexico traffic.  Coatzacoalcos, Veracruz, and Tampico are better positioned for this traffic, but a port must achieve “minimum optimal scale in order to attract sailings; Veracruz is most likely to continue to be the “load center” for this traffic.  These frequencies are critical to average transit times and inland double-stack economies.  For traffic arriving from the Panama Canal – the Port of Houston could penetrate Texas markets north to Dallas and west to San Antonio, where it could then mix with NAFTA rail traffic to/from Laredo and Mexico over Union Pacific and Kansas City Southern de Mexico routes to Monterey.  Mexico City is more likely to be served from the Pacific port of Lazlo Cardenas by KCS de Mexico.


New Orleans/Gulfport-Biloxi/Mobile (NO, G-B, M)

     The Port of New Orleans made a heroic recovery from the devastation of Hurricane Katrina.  Gulfport and Biloxi also suffered damage.  These ports are well-positioned to serve cross-Gulf traffic to Mexico, but they lack the hinterland and local population/industrial base to become major points on the Panama Canal/inland double-stack network.  Experience with a quarter century of international container export/import double-stack inland service has shown the criticality of near-port consumption areas to sustaining the international intermodal model.  This is the reason Los Angeles/Long Beach always leads the way as an anchor for DST – in contrast to, say, Oakland, Portland, or Seattle Tacoma – despite shorter sea-lane distance to the Orient.

     Norfolk Southern appears to be anchoring its “Crescent Corridor intermodal improvements on terminals at Memphis and Birmingham, rather than New Orleans or Shreveport.  These improved terminals could be fed from the Panama Canal traffic moving over South-Central Gulf ports (NO, G-B, M), but again intermodal DST economics put a premium on densities and frequencies.  It may take a number of years to sort out the most viable route for Gulf to inland traffic in the South Central region.  The best routes likely would be: 1) New Orleans-Jackson Memphis via Canadian National with an interline connection to the Meridian Speedway (KCS – NS) route at Jackson; 2) Mobile – Birmingham via CSX, NS, or BNSF; and 3) A connection to Atlanta over Birmingham (NS).



     The port of Savannah is growing rapidly and will be a major contender for Asian traffic moving in New Panamax containerships.  The draw for Savannah is its excellent connections via both CSX and NS to Atlanta.  Savannah will have wide deep-water channels, simple portside storage capacity, and low operating costs compared with its rivals.  Really, Savannah’s only downsides for handling the new traffic flows is its distance inland up-river from the Atlantic and the rail distance on to the American Midwest; this traffic would have to go back to Atlanta, then north to Cincinnati or Louisville en route to Detroit, Chicago, St. Louis, or Kansas City.



The venerable Port of Charleston should be able to participate significantly in New Panama traffic growth.  Charleston’s costs are reasonable low, and expansion potential is good.  Inland connections for DST service on NS to Atlanta, Birmingham, the Meridian Speedway, and Memphis.  Northbound, containers imported over Charleston can use CSX DST service paralleling I-95.


North Carolina

The Port of Wilmington, North Carolina anticipates substantial growth in the wake of Panama Canal widening.  The state of North Carolina is an active booster of rail service, and plans substantial upgrades along the CSX route from Wilmington to Charlotte, which should make Wilmington competitive for new DST services inland.  Also, land has been purchased near the Military Ocean Terminal at Sunny Point, NC, where a new deep-water port is planned, with ample room for future expansion – supplementing Wilmington.


Hampton Roads

The Virginia Port Authority has been expanding facilities in both Norfolk (exclusively NS-served except for Maersk's relatively new Virginia International Terminal in Portsmouth (served by CSX as well as NS) and Newport News (served by CSX).  Well-known for coal exports and U.S. Navy operations, these Virginia ports can expect huge growth in containership volumes when the Panama Canal widening is complete.  Hampton Roads offers natural deep water channels and relatively low operating costs.  CSX will use Newport News docks to access inland DST service via Richmond and its developing National Gateway.  NS will use its traditional export coal route to move DST trains west to Petersburg and beyond via its Heartland Corridor.  At Lynchburg, the Heartland Corridor intersects the Crescent Corridor, so traffic coming over the Port of Norfolk can move southwest to Charlotte, Atlanta, Birmingham, Meridian, and Memphis, or northeast to Front Royal, VA, Harrisburg, and Northern New Jersey and New England (via the Patriot Corridor).



The Port of Baltimore is a substantial distance up the Chesapeake Bay from Hampton Roads, which is a disadvantage for ship turnaround times, but an advantage in moving loads inland.  CSX would be able to use DST west and north of Baltimore, but only if large sums are invested in tunnel and bridge clearances.  The CSX National Gateway project will ­­­­­­­­­tap Midwestern markets via a new container facility near Toledo, and will make Baltimore’s port more competitive.


Philadelphia, Wilmington

These ports can be reached by containership coming up the Delaware Bay and River.  Dredging the Bay for deeper draft ships has become controversial, and major investment at these ports is unlikely.  Philadelphia does a reasonably large business with Caribbean traffic and Wilmington is a bustling banana port.  The Delaware Bay ports are significant in handling crude oil imports, but it is unlikely that this container traffic will increase substantially because of Panama Canal widening – in part because they are not well placed for inland DST service extensions.


Port of New York/New Jersey (PANY/NJ)

     Next to Houston, Savannah, and Norfolk, the PANY/NJ is likely to be the biggest beneficiary of larger New Panamax containership traffic.  The container handling facilities of Kearney, NJ are already enormous.  With new container flows inbound, these yards may become more balanced as to direction of flows and thus more efficient in utilization of DST platforms and locomotives.  The mega population surrounding New York City provides markets for inbound container traffic of all kinds, whether consumer manufactured goods from Asia or foodstuffs from the American Midwest.  International and domestic containers can meet in Northern New Jersey for transloading or re-stuffing – filling slots on container trains moving west or the holds of containerships leaving PANY/NJ for worldwide destinations.

     The Port Authority has been developing options for getting New Generation Panamax ships under the Bayonne Bridge and into Port Newark / Port Elizabeth.  The current plan calls for two expensive projects, raising the bridge and deepening the channel under it.  An alternative would kill two birds with one stone -- move the port facilities served by larger new ships east from Elizabeth and Newark to Bayonne on the Hudson River, where the Appalachian Chain falls off sharply into deep water.  (The site is the former Bayonne Military Ocean Terminal.)  Building a new super terminal there would put it east of the Bayonne Bridge and would avoid blasting a deeper channel through Appalachian schist, but it would mean costly extension of improved rail access facilities to Bayonne.  Existing rail and port facilities in Kearny, Elizabeth and Newark would continue to serve Panamax ships in the feeder trade.


Boston/New England

     It is unlikely that the widening of the Panama Canal will have significant impacts on the Port of Boston.  Its international business will continue to be oriented to Europe and the Mediterranean,



     The Canadian Port of Halifax has marvelous natural deep water channels.  It could benefit from larger Asia vessels coming through the Panama Canal and dropping container loads destined by DST for Montreal, Toronto, and Michigan.  Alternatively, at Halifax, containers could be transferred to smaller ships using the St. Lawrence Seaway to Great Lakes ports. Halifax already serves as a major “load center” for trans-Atlantic container service, and stands to expand its role in the new post-Panamax era.


North American Pacific Coast Ports – Impact of Panama Canal Expansion

Southern California

     The Ports of Los Angeles and Long Beach (LA/LB) are the largest in North America in terms of handling containers.  The explosive growth of trade between the USA and Asia has centered on the twin parts of LA/LB and, similarly, this port complex has become the largest load center for double-stack container trains operated by BNSF and Union Pacific railroads.  New facilities have been developed in and near the port complex to accommodate the growth.  In addition to private investments or contractual agreements to build and lease space for containership lines like American President, NYK, SeaLand, and Maersk, public-private partnerships have been used to create such infrastructure projects as the International Terminal Services (ITS) and the Alameda Corridor project – a double-track rail trench between ITS and downtown L.A.  There has been much discussion also of an Alameda East project – essentially continuing the Port corridor from its current end near downtown Los Angeles eastward to Riverside/San Bernardino, over routes of both BNSF and UP.

     The great advantages of the Ports of LA/LB are two – proximity to a huge commercial/economic region and space to grow.  The size of the Los Angeles Metropolitan area and its economy cannot be ignored by distribution and carriers located anywhere in the world.  It is a magnet for goods from anywhere.  DST trains bring domestic goods from all over the USA for consumption by southern Californians, and for export.  Containerships unloading at the Ports of LA/LB leave containers for local consumption as well as to fill double-stack trains returning east.  There is also a substantial local business in transferring (re-stuffing) goods inbound from overseas in international containers into larger domestic containers or 53’ over-the-road truck trailers.



This port on San Francisco Bay ranks sixth or seventh among USA container ports in volume.  It handles relatively more export than import business, in part because it is a second port of call for vessels stopping first in Southern California or the Pacific Northwest.  From Oakland, DST trains go directly east on Union Pacific’s Overland route or down the Central Valley of California on BNSF to connect with BNSF's “Transcon” line at Barstow.  They can also use UP's route in the Central Vally and continue beyond Barstow on the former Southern Pacific "Sunset Route" to El Paso, thence on UP to Kansas City (via Tucumcari, NM), Memphis, or New Orleans.  

     Union Pacific is also restoring its double-track line over the Sierra Nevada at Donner Pass, and clearing tunnel and snow-shed clearances to double-stack dimensions.  The Donner Pass route is nearly 100 miles shorter than UP’s former Western Pacific single track route via the Feather River Canyon.



     The Port of Tacoma has passed Seattle in container handlings and now ranks in the top ten USA container ports. 

     Seattle is the closest USA mainland point to Asia, and has a fine deep-water port location on Puget Sound.  The port has limited space for landside handling of containers, however.  Also the population base for matching domestic loads with international containers in substantially smaller than that of the Bay Area of California.

     The Port of Portland (Oregon) has strong traffic in bulk exports (grain, soda ash) and automotive imports, but is not a major player in container shipping.  Some investment was made for handling containers at the Columbia River site formerly targeted for export coal handling, which had to be abandoned.


Vancouver and Prince Rupert British Columbia, Canada

     Vancouver has a bustling container port and is making improvements to its landside rail connections with two competing railroads, Canadian Pacific and Canadian National.  Vancouver has profited from being open when other Pacific Coast ports were shut down by labor actions.  Vancouver has a strong position in export coal movement over its Roberts Bank facility, but container handlings are somewhat handicapped by clearance and overall capacity restrictions over the Canadian Rockies, as well as its modest metropolitan population base.

     Prince Rupert, BC, is a fine new facility whose rail connections have drawn investments from Canadian National Railway.  Close to the Orient, but far from Canada’s population centers, Prince Rupert is likely not to be much affected by Panama Canal widening.


Implications for Mexico Ports of Panama Canal Expansion

     The Gulf of California port of Lazlo Cardenas has increased in importance and is a focus for investment by Kansas City Southern de Mexico.  It is the closest major Pacific port to Panama, and therefore might be affected negatively after the widening of the Canal; that is, a containership that previously used Lazlo Cardenas, might in the post-New Panamax era want to proceed through the Canal and make Veracruz on the Gulf of Mexico its first port of call.

     There were proposals in the recent past, when LA/LB were suffering severe congestion, to build a new port about 80 miles south of San Diego at Ensenada, Baja California.  It was a reasonable proposal and might have worked, even though large investments would have to have been made in connecting rail lines for handling DST.  This is a good example of the kind of investments that will not be made anytime in the foreseeable future, because of the competitive impact of widening the Panama Canal.