BY LOGAN G. MCPHERSON It was President Hollander's desire that this discussion be specific in its treatment of the present realities of the railroad problem. There are phases of the railroad problem which come and go so rapidly that it is difficult even for the press to keep abreast of them. In recent months such phases have been the relinquishment of the operation of the railroads by the government, the governmental guarantee succeeding the relinquishment, the funding of the railroad indebtedness, the proposal that the government sell securities to obtain funds for transfer to the railroads, the car shortage, the increase in wages, the increase in rates, the reduction in rates, the reduction in wages coincident with the threat of a nation-wide strike. These passing phases are as the waves to which the winds and the currents give rise. The winds and the currents are the realities all of the time and therefore the realities of the present at any time that may be present. Among the definitions of "reality" in the Oxford dictionary is this: "Real existence, that which underlies and is the truth of appearance or phenomena-That which constitutes the actual thing as distinguished from what is merely apparent or external.” In accordance with this definition the underlying reality of the railroad problem is in the fact that the ultimate purpose of the railroads is to serve, protect, and promote the industry and commerce of the United States, and thus to conduce to the material welfare of the people of the United States. The degree in which this purpose is served largely depends upon the adjustment between the current of the receipts and the current of the expenditure of the railroads which are ever played upon by the winds arising from the varying interrelations between the supply of and demand for all that the railroads transport. There ought to be the adjustment, leading in the greatest attainable degree to the continuous fulfillment of this ultimate purpose, between that which is received by the railroads from the sale of transportation and that which they pay for its provision. This includes that adjustment which will enable the necessary extension of their facilities to meet the requirements of an increasing industry and commerce. And there ought to be established the conditions which give incentive to the utmost efficiency in the utilization of all which is applied in providing transportation. That is the railroad problem. The predicament in which the railroads have been for many years is due to the lack of such adjustment, and to the fact that their efficiency has been impaired by conditions they are struggling to overcome. The principal causes which have acted during the past twenty years to bring about this predicament are found in a long series of contentions, which in the main were settled not in recognition of the principles which must be observed if the ultimate purpose of the railroads is to be upheld, but to quiet popular clamor instigated by those who sought to promote their own interests to the neglect of the protection of the railroads. An extending belief that the railroads, instead of being everlastingly censured and harassed, ought to be placed under conditions which will enable them to serve their purpose, led to the enactment of the Transportation Act of 1920. This act recognizes the necessity for the railroads to have a net operating income, a surplus of receipts over expenditures. In this respect it is a distinct advance over previous railroad legislation. It stipulates that the annual net railway operating income, as nearly as may be, shall be a fair return upon the fair value of the railway property. It provides that for the two years beginning March 1, 1920, such fair return should be equal to five and onehalf per centum of such fair value, but that the Interstate Commerce Commission might at its discretion add thereto a sum not exceeding one-half of one per centum of such fair value. At the expiration of the two years the Commission is authorized to determine from time to time the percentage which will constitute a fair return. It evidently is the intent of the Transportation Act that the service of the railroads is to be provided by receipts from the sale of transportation, not in any degree by taxation. If the railroads are maintained by the receipts derived from the sale of transportation, the cost of providing the service tends to be diffused among the people in proportion to the benefits they derive, the cost of transportation is included in the prices paid for all which they use and consume. If the railroads are maintained by taxation the cost tends to be diffused in disproportion. To the extent that deficits are paid from taxation they tend to be diffused in disproportion. During these two years the net railway operating income has not equalled the specified five and one-half per centum. In 1920 the railroads had the greatest traffic and the greatest gross revenue from the sale of transportation in their history. Their operating expenses were also the greatest in their history, so high that their net operating income was equivalent to only onetenth of one per cent of their property investment. This was notwithstanding that in 1920 the railroads produced 21 per cent more revenue ton miles with approximately 2 per cent increase in freight train miles, and 39 per cent more passenger miles with fewer train miles than in 1916, the year before the operation of the railroads was taken over by the government. For 1916 the net operating income was equivalent to a fraction less than 6 per cent on the property investment. These two years have been a period of readjustment attended with abnormal conditions which the nations are endeavoring to remove in order that the normal processes of industry and commerce may be restored. The two years expire March 1, 1922. Then under the Transportation Act it will be the duty of the Commission to determine the percentage of the aggregate value of the property of the carriers which will constitute a fair return, and so to adjust rates that their net railway operating income shall at least be equal to such percentage. That is, on the first of the coming March the Interstate Commerce Commission is to determine what shall be a fair reward to the railroads for providing the service of transportation and to adjust railroad rates in order that they may receive that reward. This determination of the Commission will involve, not the disposition of earnings received but an estimate of the future. If the estimate is not verified and the net operating income falls short of the percentage, there is no way in which the railroads can recuperate the loss. This is a reality of the transportation problem of first and foremost importance. The Commission is directed to determine the fair value of the property of a carrier and of the carriers under the provisions of the Valuation Act signed by the President March 1, 1913, which is incorporated in the Interstate Commerce Law as Section 19-a. It does not need to be pointed out to a body of economists that the value of a thing is not what it costs but what can be obtained for it at the time of sale; that the value of that utilized by an organization engaged in production is not determined by its cost but by the return derived from the sale of utilities produced by means of the utilization. Value is the price obtained at time of sale or the price which could be obtained in case of sale. Prices in the normal course of industry and commerce are determined by interrelations between supply and demand. The value of a business organization to its customers is determined by the things and services they buy from it, that is, by its serviceability to them, and this is indicated by the prices they pay. Its value to its employees is determined by what they receive for what they sell to it, that is, by the wages, the prices paid to them for the effort they exert in its behalf. Its value to those from whom it buys materials and supplies is determined by what they receive for what they sell, that is, by the prices paid for them. Its value to its bondholders depends upon what they receive for what they sell, that is, upon the interest, the price paid for the use of capital provided by them. Its value to its stockholders depends upon what they receive for the proprietary investment made by them. This is profit in the form of net income whether paid to them in dividends or retained as surplus. The degree of value to the stockholder depends upon the degree in which the total expenses of production are kept below the total receipts from the sale of that produced. To determine the valuation of a railroad company is not to arrive at the cost of its physical assets or the price at which those physical assets could be replaced. The cost of such assets may have been greater or less at one time than at another; it may cost more or less to replace them at one time than at another. A railroad company is seldom sold and bought in its entirety, but its value is reflected in the value of its stocks and bonds; that is, in the prices they will bring at the time of sale. This valuation in actual practice is the result of the judgment of all effective buyers and sellers as to the benefits they believe may be derived from selling them or buying them. These prices are indicated by the market quotations which vary from time to time, even from day to day, as these judgments vary. These various judgments of buyers and sellers are determined mainly by the net earnings of a corporation and by the estimates of the probability of their continuance, of their increase or decrease. Therefore, as value is determined by what is received or what can be received and not by what has been paid, the sense in which the terms "value" and "valuation" are used in the Valuation Act and in all of the discussion and procedure to which that Act has given rise, is in the sense of placing the cart before the horse. After much discussion and experiment the procedure under the Valuation Act was devoted virtually entirely to the endeavor to ascertain the cost of reproduction new, or the cost of reproduction less depreciation, of the property, that is, of the physical assets of a carrier. The Commission has allowed an addition of seven and one-half per centum to this cost for appreciation due to the coördination of the physical assets and the serviceability of a railroad company as a going concern. The total thus ascertained has been designated the value of a railroad company. As the physical assets of a railroad company are indispensable to the performance of its service, it follows as a matter of course that those who provide the capital necessary to their acquirement must receive adequate reward for the utilization of that capital; and it follows that the railroads must offer adequate reward for the additional capital requisite to the extension of their facilities for the increased provision of transportation. For the latter purpose the Transportation Act authorizes the Commission in its discretion to allow a carrier a sum not exceeding one-half of one per centum of the fair value of its property in addition to the fair return accorded as the reward for the use of the property. The percentage to be allowed as a reward for the use of capital and as provision for the extension of facilities constitutes the net railway operating income of a railroad company. This is the proportion of the receipts derived from the sale of transportation which remains after the current expenses, the running expenses for providing transportation, have been met. These running expenses include wages and salaries and the cost of materials and supplies. Those who pay for the service of transportation must pay a total constituted of expenses incurred for wages and salaries, for materials and supplies, for repairs to and renewal of physical assets, and sufficient in addition to yield the specified net railway operating income. Although it presumably is the intent of the Transportation Act that the railroads shall to the utmost attainable degree serve, protect, and promote the commerce of the United States, and there are certain provisions which evidently are intended to have that effect, nowhere in the Transportation Act nor in the Interstate Commerce Law as a whole is that purpose specifically stated. Reference to railroad rates is made in such terms as fair, just, and reasonable; and it is held that there ought to be honest, |