The Surface Transportation Board will hear from industry stakeholders on ways to solve reciprocal switching over two days in March 2022.
Reciprocal switching happens when a shipper has access to one freight railroad but wants to transfer to a nearby competing freight railroad to maintain a competitive pricing environment. President Joe Biden issued an executive order in July directing STB Chairman Marty Oberman to investigate the matter and, if necessary, begin regulation. While the practice is limited in the United States because of long-standing rail-shipper agreements, it has long been practiced in Canada and is known as interswitching.
Rail shippers originally asked the board to take up the issue over a decade ago, claiming that reciprocal switching advantages captive shippers, or those who only have access to one railroad. Detractors, on the other hand, point to operational obstacles and potentially detrimental economic consequences for the rail industry if reciprocal switching is introduced.
Steve Pociask, an economist of the American Consumer Institute Center for Citizen Research, a nonprofit think tank dedicated to examining how public policy affects consumers, is one of the critics of reciprocal switching. “Veering Off the Rails: How the Recent Push to Reregulate Railroads Threatens Consumer Welfare,” a report he co-authored with Liam Sigaud in October 2021.
Pociask spoke with FreightWaves about the report recently. For length and clarity, the following question-and-answer interview has been edited:
FREIGHTWAVES: In March, the STB will hold a two-day hearing on reciprocal switching. What should board members bear in mind as they prepare for the hearing by taking in all of this information?
“There are a couple of things,” POCIASK says. I think they should look at the history of what has happened [with freight rail regulation] and what the impact has been — and then… [the] analogies where we’ve seen similar things applied to other industries, and then the entire issue of why do we regulate in the first place. What is the point of it? Is this something that addresses a previously identified market failure?
“One of the conclusions we got to was that this whole concept of reciprocal switching amounted to corporate welfare in the sense of kowtowing to rent-seekers and lobbyists in certain ways.” What good is regulation if we can’t identify a serious market failure that necessitates government intervention? There is a slew of issues that need to be addressed and investigated further.
“Of course, I’m sure your readers are aware of the success of what happened as a result of the Staggers Act, with lower costs and rising productivity, as well as increases in consumer welfare that ranged from 10 to 18 billion dollars per year in actual money, depending on the study.” When you add together all of the reforms that occurred over that time period [for trains, airlines, and truckers], we’re talking about well over a hundred billion dollars in consumer welfare. Customer welfare is a well-known and widely used indicator of consumer benefits.
“The Staggers Act’s consequences made it plain to me and Liam that what we were seeing here was enhanced rate flexibility, allowing movement to make investment decisions, going into private contracts – those kinds of things altered the entire industry, just like they did in the airlines.” We switched to hub-and-spoke networks, which resulted in lower prices. Interestingly, that was another instance, similar to rail, where a Democratic legislative body and president signed these bills into law… Of course, there must always be protections in place for safety, particularly for consumers. However, it is not in the public interest to deprive the industry of its opportunity to invest in safety. That’s one element of it, at least. We need to take a step back and consider what happened, if we want to go back there again, and what the implications would be.
“My opinions here do not represent the FCC’s [Federal Communications Commission] views, but I chair the FCC’s consumer advisory committee, so I’ve dabbled a lot in understanding what’s going on in the regulatory and communications sectors.” And there are some fascinating parallels between what happened then and what could happen now in the rail industry.
“There were a lot of intriguing regulations that were similar [to reciprocal switching] up to the early 2000s, I believe 2002.” One was [in the telecoms industry]… a mechanism through which an incumbent local exchange carrier would be forced to essentially make its network resources accessible to competitors at [heavily] discounted pricing. … Supporting resellers, on the other hand, did little to grow or increase competition.
“What I’m trying to argue is that there are some interesting similarities in place that indicate how forced access, as well as price limits, fail time and time again.” Price limits tend to stifle innovation and, perhaps, consumer safety, while also causing shortages. And this is a foreshadowing of what could happen here, as train carriers may be forced to reduce their spending. And there’s nothing positive about it.
“To some extent, what this boils down to is why should we regulate in the first place?” What is the purpose of this rule? And, in a very fundamental sense, people control when there is an externality: I’m contaminating a river, killing fish, and the fishermen are [affected]. ‘Wait a minute,’ there’s a cause to step in and say. Because you’re contaminating that river and causing injury to someone else, you’re not actually paying the social costs.’
“There’s also the problem of market failure to consider.” And it is for this reason that the government is sometimes called in as a last resort. So, in terms of market structure, industry conduct, industry performance, and the like, my study and Liam’s look at what’s going on. It’s a straightforward way of asking, “Can we spot a market failure here?” And that’s a big part of the study because the appearance of a market failure usually justifies some regulation. However, determining whether a market failure occurs is merely the first step in determining whether intervention is even worthwhile. Because it turns out that even flawed markets can surpass government rules on occasion. So the question is: Have we discovered a market failure? And I’m not convinced we’ve done so.
“If you look back over the years, for example, there have only been a few shipper complaints, but nothing significant enough to warrant reciprocal switching….” There hasn’t been a single example where the board has recognized an… action that would justify reciprocal switching, in my opinion. So, if we can’t tell whether a market failure occurs, why do we need a regulatory remedy to address it? And that raises the question of what the point of it all is. This, I believe, encapsulates the concept of rent-seeking. So we have a group of shippers who filed a complaint, and the complaint resulted in some action in the form of proposed rulemaking, and we now have a hearing scheduled for mid-March to debate this.
“Lobbying is what rent-seeking is in its most basic form….” Rent-seeking is a branch of economics that first appeared in the 1960s. Rent-seeking is essentially lobbying or stretching time and resources to transfer wealth between corporations without increasing the economy’s overall benefit. It’s as if someone were attempting to step in and extract money or compensation from rail companies as a direct advantage to [the person stepping in], without necessarily improving social welfare. And that’s sort of the point of this. The government’s subsequent concession to reciprocal switching is simply corporate assistance.
“The first step is to recognize that there is a market failure.” And if we can’t identify a market failure, there’s no need for the government to intervene. And what they’re actually doing is trying to help someone at the expense of someone else. The purpose of the report is to show that the enterprises in that association are not impoverished. They don’t require financial assistance. And transferring wealth isn’t always a better method to improve society’s overall well-being. That’s the main takeaway from it.
“There are other factors, too, such as returning to the analogy of what happened in telecom….” It was DSL vs cable back then, and that was the pre-fiber broadband service that consumers received. When these rules were enacted in 1998 or 1999, cable had a market share of 40 to 45 percent… compared to DSL.
“Incumbent local exchange carriers were inhibited from investing in broadband services as a result of compelled access… [and] the onerous expense of regulation and the dangers associated with renting facilities to competitors at low costs.” As a result, by the time the limits were abolished, cable had nearly doubled its market share, rising to 75%.
“I believe it will eventually shift a lot more traffic to trucking, which will be bad for the railroads.” If rail investment begins to decline, the demand for trucks will inevitably arise. What does this mean in terms of implications? What effect does it have on our roads? What impact does this have on the environment and infrastructure? As opposed to rail, which is supported by private capital?
“In my opinion, the board should take it slowly and be cautious about going into this.” They must prove not just that there is a market failure, but also that their remedy surpasses what may be considered a market flaw. They must first identify the flaw, after which they must show that the benefits of such regulation will outperform or outstrip the costs. Otherwise, their actions are akin to corporate charity.”
FREIGHTWAVES: How might a market collapse in rail look like?
POSCIAK: “There are three ways to look at it: structure, conduct, and performance.” If you see unusually big earnings, that’s usually a sign that something’s wrong, that my prices are significantly greater than my costs. However, if you look at the earnings of the corporations that have complained to the board, you’ll notice that they’re higher than the ones they’re trying to regulate.
“Another way to look at it is to say that the industry isn’t reinvesting — for example, if it’s milking the cash cow….” However, it does invest a significant portion of its cash flow. As a result, it does not appear that way.
“There are a few things you look for: Are they holding prices up to the point where demand is being restricted? In a way, he’s your typical monopolist. If those things aren’t happening, then there isn’t a market failure in that type of offense.
“I think it’s critical to look back at the regulatory reforms that occurred and consider the comparisons and other cases of forced access that have occurred.” They were complete flops. Those decisions were overturned by the FCC.
“Ask yourself why we’re regulating in the first place.” Is there a market failure that we’ve discovered? Is the quantitative analysis complete? Do we really know if the advantages of this proposal will exceed the costs? What effect does this have on consumers? Why are we focusing on shippers rather than the impact on consumers? In the end, what matters is how much better off consumers are and how much safer the rail is.
“The irony of it all is that we now have a Democratic legislature and president, which is exactly what we had at the time the Staggers Act was passed.” And I find that fascinating because the end outcome of all of this might have significant environmental consequences, such as increasing the number of trucks on the road and affecting infrastructure, as well as the potential for pollution and other issues. So the question is, “Why are we doing this, and is it really necessary?”
