Train Drain
I know of Phillip Longman more so from his authoring a couple books. One called “The Best Care Anywhere” about the Veterans Administration. This is an article about deregulation and what happens when private equity takes over. It is a good read.
Deregulation and private equity have gutted the U.S. freight rail system—and with it, the promise of America’s industrial renewal.
Train Drain, Washington Monthly, Phillip Longman
For all our differences, Americans are remarkably united on one key point. Partisan Democrats and Republicans, business and labor leaders, and just about all the folks sitting in think tanks or on barstools across this great land agree that we must start making more stuff in America.
President Donald Trump, of course, pursued this goal primarily by imposing tariffs and ran for a second term promising to impose far more. The Biden-Harris administration maintained many of Trump’s original tariffs and added some new ones while also creating deep subsidies for many forms of domestic manufacturing, particularly computer chips and green technology.
Responding to these incentives as well as to the supply chain fragilities revealed during the pandemic, many corporations have started building more factories in the U.S. or have announced plans to do so. Some of the deals sound impressive. In March, Intel announced plans to invest $28 billion in the world’s largest chipmaking complex on a site in New Albany, Ohio, for example.
But overall, the scale of actual and planned manufacturing construction is rather modest. According to an analysis of current trends sponsored by the Commercial Real Estate Development Association, the total number of square feet devoted to major factories is expected to rise by just 6 percent to 13 percent over the next 10 years.
Why so little? Many well-known factors work against the growth of American manufacturing, including shortages of appropriately skilled labor. Permitting requirements and other red tape can also make building a new factory in the U.S. cumbersome and expensive. But even if these challenges were overcome, there is another huge factor threatening the rebuilding of America’s industrial base and transition to a greener economy.
In order to make stuff in the U.S., you must be able to efficiently transport not just finished goods to consumers but also lots of heavy raw materials and components to your factories. For example, making EV batteries in the U.S. requires making synthetic graphite, and making synthetic graphite requires transporting huge volumes of feeder stock like coal tar or petroleum coke, which are by-products of steel production and oil refining. You can’t use trucks to move that much heavy material for more than short distances—not even trucks running on battery power. You need freight trains.
Yet our freight rail system is melting down. After being deregulated in 1980, freight railroads merged into a handful of giant monopolistic systems that became highly profitable. Those profits, plus the lack of regulation, in turn attracted financiers who over the past decade have taken control of major railroads and forced them to adopt a new predatory business model. Financiers are maximizing short-term profits and returns to shareholders by effectively liquidating the rail system through radical downsizing and degraded service, all while further damaging the prospects for American manufacturing by charging higher and higher freight rates.
To deal with their diminished capacity and crew shortages, railroads have frequently imposed embargoes—refusals to accept new traffic—causing freight to stack up in warehouses and in railcars that remain stranded in yards and sidings for days and even weeks. At one point in 2023, millions of chickens faced starvation because of Union Pacific’s failure to deliver animal feed trains on time. Shippers who depend on railroads are often reluctant to voice public criticism for fear of retaliation, but through their trade associations they describe systematic breakdowns in service that prevent them from growing. In September, Jeffrey Sloan of the American Chemistry Council testified before the Surface Transportation Board that railroads threaten the safety and growth in the chemical industry through “excessive rates and charges, unreliable service, and a lack of network resiliency.”
This state of affairs does not bode well for a manufacturing renaissance. Today’s stripped-down U.S. rail system does passably well at moving Chinese imports from West Coast ports to retailers like Amazon and Walmart. And it still handles large reverse flows of bulk commodities like coal and grain. In this, American railroads have become like the ones the British Empire once constructed in India and other colonies: optimized for importing manufactured goods and for exporting natural resources. But under their current ownership and operating plans, America’s downsized freight railroads are not configured to accommodate any significant reshoring of heavy industry, whether it’s petrochemicals, steel and shipbuilding, or EV batteries and windmills.
Meanwhile, the continuing degradation of the freight rail system is causing many other harms to the public. For example, it’s forcing many shippers to shift from rail to pollution-spewing heavy trucks that cause extensive damage to roads and bridges and that kill or injure a surging number of Americans every year. Freight transportation may seem like a banal subject. But getting it right is key to everything from fixing global warming and improving public health to overcoming dangerous dependencies on geopolitical rivals.
To understand this problem, we have to know what has caused it. In short, this is a story of what happens when you deregulate an essential infrastructure, allow its managers to extract monopoly prices from captive customers, and then let assorted wolves of 21st-century Wall Street to gain control and take the whole system over the edge.
By the late 19th century, even proponents of laissez-faire had come to realize that without regulation railroads threatened to distort the workings of the free enterprise system. In most places, a single railroad held a local monopoly, which it used to extract wealth from the community and retard its economic development. Meanwhile, in places served by more than one railroad, typically large mid-Atlantic cities, the competing carriers often engaged in price wars, giving those places an unfair and unearned economic advantage over rural America and midsize heartland cities.
In response to these and other inequities, many states began regulating railroads as far back as the 1860s. In 1887, Congress extended railroad regulation to the federal level by passing the Interstate Commerce Act, which forbade railroads from charging more to transport “like kind of property, under substantially similar circumstances and conditions, for a shorter than for a longer distance over the same line.”
It would be many years before the Interstate Commerce Commission overcame resistance from reactionary judges and gained full statutory power over railroad rates. But by the early 20th century it was effectively setting the industrial policy of the United States by controlling how much railroads could charge for shipping different kinds of products to different places. The ICC also gained the power to end the widespread, market-distorting practice of railroads offering discounts or rebates to powerful shippers, such John D. Rockefeller’s Standard Oil monopoly.
Guiding the ICC’s approach to regulation was a principle known as “common carriage,” which is akin to what we today call “net neutrality” in debates over internet governance. Shippers, regardless of their market power, had to pay roughly the same price per ton and per mile for transporting the same kinds of goods for the same distance. Where railroads lost money on low-volume and high-cost services, such as serving a grain mill at the end of a branch line used by local farmers only at harvest time or running local passenger trains, they were expected to make up the difference from their high-profit routes and lines of business.
The bureaucratic processes the ICC used to enforce a neutral, public rate structure were often protracted. It had to determine, for example, what should be the relative price of shipping a hog versus a ham 50 miles. Yet this regulatory structure was nonetheless critical to ensuring fair terms of competition between different businesses and different places and thereby helped launch America as a broadly prosperous economic powerhouse.
Many other resource-rich countries, like Argentina and Australia, were slow to develop domestic industries in the late 19th and early 20th centuries. The U.S., by contrast, not only took off early but also developed in a way that distributed growth to midsize cities across its hinterlands. Rural America was also unusual in that it supported a large class of free-holding, independent farmers who had access to distant markets. What explains the difference? In a recent essay, Noam Maggor, a historian at Queen Mary University of London, documents one often overlooked factor: the great and unusual advantage the U.S. gained by regulating railroads in ways that preserved equal pricing and terms of service across all regions.
Starting in 1935, the ICC began applying the same principles to interstate trucking. This was critical to ensuring that railroads and truckers competed under the same rules. By limiting the number of commercial interstate truck licenses and the freight markets individual truckers could serve, the ICC also preserved at least the possibility of each mode being put to its optimal use, such as using trucks for local and expedited regional deliveries, and fuel-efficient railroads for longer hauls.
All this went by the board just as the country faced an energy crisis and a growing environmental movement. In 1980, President Jimmy Carter signed legislation that stripped the ICC of nearly all its power to regulate rail rates and substantially reduced common carriage requirements as well. That meant railroads were free to offer secret discounts to powerful shippers just as they once did for Standard Oil. It also meant that railroads could exercise virtually unrestrained pricing power over what’s known in the industry as “captive shippers”—that is, mines, factories, or refineries that are served by a single railroad and that are unable to use trucks as a substitute because of the bulk and weight of what they need to move. And finally, deregulation meant that railroads could simply refuse to serve individual shippers and whole communities, as they were prone to do so long as they could make more money pursuing different lines of business.
At the time, many policy makers thought that deregulation would put off a pressing issue. The decline of manufacturing in the Northeast and the industrial Midwest was causing many railroads to fail, raising the specter of the government having to engage in a permanent takeover. Policy makers in both parties hoped that deregulation would help them avoid that scenario. Many were also influenced by sustained ideological attacks on regulation that were being mounted in that the era not only by “free market” conservatives but also by many Democrats worried about inflation and U.S. competitiveness. The consumer activist Ralph Nader and liberal Democratic Senator Ted Kennedy were united in their calls for abolishing ICC regulation of both railroading and trucking, just as they had successfully worked two years before to dismantle regulation of airlines.
At first, the plan seemed to work. The bankrupt railroads in the Rust Belt merged into a regional monopoly called Conrail, which then became highly profitable by abandoning unprofitable or low-margin lines and customers, and by taking advantage of its ability to price-gouge captive shippers. The federal government even made money on the emergency loans and equity infusions it had once used to get Conrail started. Other privately owned railroads also became highly profitable by merging and taking advantage of their freedom from price regulation and common carriage obligations. But before long, the railroads’ monopoly power began to attract the attention of financiers, and that’s when the real destruction began.
Over the past decade, “activist” investors have gained effective control over most rail management. Their first order of business was to install new managers who would drive up short-term profits through ruthless cost cutting and downsizing. The most notorious of these was the hard-charging railroad executive E. Hunter Harrison, who pioneered a new business model called “precision-scheduled railroading,” or PSR, that has now been almost universally adopted by the nation’s major railroads. Despite its label, PSR has little to do with running trains on time. Instead, it mostly involves the common private-equity playbook of driving up share prices by downsizing workforces, selling off assets, and degrading services while raising prices. It is estimated that Harrison, who was affectionately known as the “trains whisperer” by Wall Street, created $50 billion in increased returns to shareholders during his tenure as CEO of four major North American railroads.
Using this strategy, railroads have cut expenses to the point that they now spend as little as 60 cents for every dollar in revenue they take in. But this has come at great expense to individual shippers and increasingly to the economy as whole. Railroads have raised the cost of shipping by rail nearly 30 percent faster than the rate of general inflation since 2004, with captive shippers facing especially steep price hikes and other added fees. Meanwhile, railroads have cut their workforces by approximately 30 percent since 2014, scrapped thousands of locomotives and freight cars, and abandoned many branch lines and low-margin lines of business—all while also running longer and longer trains on less and less track to fewer and fewer places less and less often.
After Harrison brought the PSR business model to the rail giant CSX in 2017, the effects on shippers were devastating. A typical complaint came from the Charles Ingram Lumber Company, of Effingham, South Carolina, a third-generation, family-owned company that shipped approximately 130 million board feet of lumber made from southern yellow pine per year—or tried to. The company’s troubles began when CSX, which controls roughly half of all rail infrastructure east of the Mississippi River, decided to tear up the low-volume branch line leading to the Effingham mill. This forced the lumber company to use trucks to reach the nearest remaining railhead, seven miles away. Then CSX began refusing to provide the company with enough railcars to fill its orders or to provide timely pickup, forcing the company to tie up $750,000 in inventory that it could not get delivered to its furious customers. These days, as railroads continue to downsize their rolling stock, many shippers who want to use rail cannot even count on railroads to supply the freight cars they need and wind up having to buy or lease their own, driving up the incentive to switch to trucks whenever possible.
Railroads have also been purposely driving away customers by eliminating direct service. For example, in 2017 CSX announced that as part of its new PSR operating plan, it would no longer handle movements of containers between 327 different city pairs. It followed up in 2018 by eliminating intermodal service between another 230 city pairs, including all service to Detroit and service between Miami and such major cities as Baltimore, Philadelphia, Memphis, Nashville, and Cincinnati. During an earnings call with investors, CFO Frank Lonegro made clear that CSX’s goal for its intermodal business was to “take 7 percent of the volume off the railroad intentionally every year, because we shouldn’t be doing that kind of work.”
Why brag to stock analysts about losing customers? By shedding lower-volume, lower-margin business, CSX and other railroads free up their diminishing track capacity and shrinking train crews for more lucrative business. For instance, hauling lumber from a single mill down a weedy branch line is a low-margin business because it involves comparatively low volume and a higher handling cost. For the same reason, moving containers less than 500 miles between midsize cities is also less lucrative. By contrast, hauling large volumes of grain or coal long distances for shippers who cannot economically use trucks is a high-margin business, as is hauling containers full of merchandise made in China from the West Coast ports to major East Coast metro areas. So railroads optimize their systems to handle the latter two kinds of movements while demarketing anything less profitable.
Where railroads cannot fully get rid of lower-margin business they find ways of at least discouraging it. For example, every day in Chicago, thousands of containers bound to and from small and midsize cities are unloaded from trains, then “rubber-wheeled” across the city by trucks and reloaded onto other trains for the rest of the journey. The process adds between $200 and $400 to the cost of each container, and is also very time consuming. Faced with this kind of delay and inefficiency, many shippers just switch to trucks exclusively.
Why don’t railroads just offer direct through services between midsize cities? Because they don’t want to displease their shareholders by using their limited track capacity for lower-margin, short-haul business. And they don’t want to invest in new capacity, as that would leave less money available for rewarding today’s shareholders with dividends and stock buybacks even if it would help grow new business in the long run.
The payouts to shareholders have been extraordinary. From 2010 to 2021, railroads spent an astounding $183 billion on dividends and stock buybacks, which is far more than the $138 billion they spent on their infrastructure. It was also far than more than the cash flow railroads had available even after reducing operating costs to the bone and liquidating assets. To make up for the gap, railroads have deferred maintenance of their tracks and other capital assets while taking on more and more debt.
Take Union Pacific, for example. It operates the original “transcontinental railroad” that linked Omaha with the West Coast in 1869. Today, through a series of mergers, it also controls roughly half the rail infrastructure west of the Mississippi. Though it uses the motto “Building America,” mostly what it builds today are returns to shareholders, due to its capture by hedge funds. In 2021, for example, UP used nearly $4 billion more paying out dividends and engaging in stock buybacks than it had available from its cash flow, which is akin to paying out more in rent than you have available after taxes when you cash your paycheck. Meanwhile, because of shrinking capacity and crew shortages, UP declared more than 1,000 embargoes in 2022 alone, thereby aggravating supply chain bottlenecks and inflation.
Yet Union Pacific’s downsizing was still not enough to satisfy Soroban Capital Partners, a hedge fund that in early 2023 used its $1.6 billion stake in the railroad to demand that UP sack its CEO and replace him with someone who could wring out still higher returns to shareholders. As a result of this ongoing pressure to maximize profits, UP has had less money for keeping up its track and other physical assets, which in turn has resulted in a tab of $100 million for deferred maintenance. Succumbing to hedge fund demands has also encumbered the company with soaring financial debt. From the end of 2017 to the end of 2023, the burden of UP’s debt soared from 1.6 times its net income to 5.1 times.
Similarly, from 2016 to 2023, Norfolk Southern, which along with CSX controls most rail infrastructure east of the Mississippi, spent $8.4 billion more on dividends and stock buyback than its cash flow provided. The money likely would have been better spent on safety and operational maintenance. After the 2023 wreck of a Norfolk Southern train in East Palestine, Ohio, that sent a mushroom cloud of toxic chemicals across 16 states, federal investigators laid blame on the company’s insufficient investment in wayside sensors that could have detected a failing roller bearing. Norfolk Southern subsequently tried to restore investment in improving service and attracting new customers, but once it began to do so, it was attacked by hedge funds demanding that its managers either boost returns to shareholders or step down. In response, the railroad has recently hired a Hunter Harrison protégé to help it more fully implement PSR.
The breakdown of the freight railroads has deep consequences that go beyond America’s industrial potential. In a 2021 speech, Martin J. Oberman, then chairman of the Surface Transportation Board, noted that there would be 1 million fewer trucks on the road and 8.2 million fewer tons of carbon in the atmosphere if railroads had not ceded so much market share to trucks over the previous two decades.
And that’s hardly a full accounting. Trucks are much less energy efficient than trains, mostly because rubber tires rolling on asphalt create a lot more friction than steel wheels rolling on steel rails. Railroads can carry a ton of cargo for 472 miles on a single gallon of diesel fuel, making them at least three times more fuel efficient than trucks. Trucks also cause almost five times more fatalities, and almost a dozen times more injuries, for every ton of cargo they carry. And they, of course, impose costs on the rest of us in the form of traffic congestion and damage to publicly maintained roads and bridges. Taking into consideration all these direct and indirect costs, the Congressional Budget Office calculated in 2014 that the societal cost of moving a ton of freight by truck was about eight times higher than moving it by rail.
The high environmental cost of relying on trucks will remain even if all trucks in the future run on batteries charged with renewable energy. The consulting firm Oliver Wyman has calculated the effects of converting the nation’s entire truck fleet to EVs while continuing the current trend of moving an ever smaller share of freight by rail. Because trucks are so much less energy efficient than trains, under this scenario the U.S. would have to generate an extra 230 terawatt hours of electricity by 2050. To produce that much electricity using solar power would require covering 800 square miles of land with solar panels.
What can be done? Going forward, we minimally need to find a way to loosen the monopoly power of railroads over captive shippers. So long as manufacturing in America entails being at the mercy of a predatory rail monopoly, both foreign and domestic companies have powerful incentives to avoid building new manufacturing facilities here. The Biden-Harris administration took a step in the right direction by supporting new “reciprocal switching” regulations that will, in some egregious cases, give some shippers more options in which railroads they use. But the many deeper problems remain.
Tackling those will probably take some combination of reregulation and direct public investment in rail infrastructure. Regulation needs to ensure that railroads still have obligations as common carriers, meaning that they must not engage in price discrimination and purposeful demarketing of all but the most profitable lines of business. Regulation also needs to be extended to and harmonized with other transportation modes so all modes can compete on even terms and in ways that serve the public interest. This means setting rules of competition that favor trucking for short hauls and express service but that shift as much freight as is feasible to safer, more efficient, less environmentally destructive trains.
Enacting this kind of regulation would probably cause most vulture capitalists to quickly sell off their stakes in railroads because it would severely reduce the opportunities for monopoly pricing in the sector. That will leave the problem of how railroads can attract the capital they need to serve shippers and communities that don’t necessarily offer opportunities for earning high returns.
Some of this challenge can be met, as it was under the ICC, by using common carriage and price regulation in ways that effectively create cross-subsidies. Regulation can force railroads, for example, to use some of the high profits they earn from hauling coal on heavily trafficked mainlines to support lower-margin service, such as hauling boxcars or containers along branch lines or between midsize cities. But in some instances, direct government support may be needed to achieve these ends. This could include direct subsidies to private owners so long as they are attached to claw back provisions for poor performance, or it could include public ownership of specific rail infrastructure needed for passenger service and lower-volume freight.
As during the era before America deregulated its freight transportation sector, finding the right mix of policy tools will not be easy. But at a time when we need a vital, efficient, and equitable freight system more than ever to achieve key national purposes, we cannot afford to ignore the challenge.