The Railroads in 1870s-1880s: The Great Cartels

The answer to competition was better cooperation. Formal federations were created, and they were soon to have their own legislative, executive, and judicial bodies. The largest and most powerful of the roads—the trunk lines—were the first to organize formal cartels.

The move toward federation came in the summer of 1874, as falling traffic intensified the pressure to cut rates.34 That summer the presidents and the general managers of the Pennsylvania, the Erie, and the New York Central (but not of the Baltimore & Ohio) met, together with the senior executives of their western connections, at Saratoga Springs. According to Thomas Scott, who had just replaced J. Edgar Thomson as the Pennsylvania’s president, these men hoped, as had their counterparts twenty years earlier, “to abolish all commissions, agencies and outside expenses” involved in obtaining traffic. Of more importance the roads established an administrative office, the Western Railroad Bureau, to maintain rates between east-west competitive points. The bureau was to have the power of enforcement, including the dismissal of railroad em- ployees who knowingly cut rates. In addition, the three roads set up a commission to provide what they hoped would be considered an objective outside agency to review and supervise the ratemaking process:

A commission to be composed of three gentlemen familiar with railway traffic, but disinterested and in no way officially connected with the Companies; this commission to have power to make such moderate rates from time to time as would be reasonable and just to the public, and give in the future equal and uniform rates to every shipper.35

The presidents of the three trunk lines traveled to Baltimore in No- vember to try to persuade the conspicuously absent Garrett to agree to these proposals. The president of the Baltimore & Ohio hesitated. He wanted to see what effect the completion of a nearly finished line into Chicago would have on the business of his road. He hoped that the round- ing-out of his self-contained system might forestall the need for joining the cartel. Before the end of the year, however, the Baltimore & Ohio had reduced its rates on grain and other fourth-class freight between Baltimore and Chicago, and its competitors followed suit. In 1875 a new contender, the Grand Trunk of Canada, operating from Portland, Maine to Detroit via Montreal entered the east-west competition. It did so by temporarily allying itself with the Michigan Central and the Vermont Central to give it connections into Chicago, Boston, and New York.36 Immediately it cut its rates to obtain traffic. In the next year came the sharpest rate reductions the country had yet seen. In the drawn-out negotiations that followed, the merchants of Baltimore and those of Philadelphia had joined their railroads in demanding that the rates from the western cities to their ports be lower than those to New York, while New England businessmen supported the Grand Trunk in its call to keep rates to Boston and Portland the same as those to New York.37

Finally in the spring of 1877 the exhausted roads agreed to compromise.38 On May 5 the trunk lines signed the Seaboard Differential Agreement and created a new interfirm organization to carry it out. The new rate structure followed the demands of New York City’s rivals. Philadelphia and Baltimore received somewhat lower rates on westbound traffic than New York had, while Boston’s remained much the same. On May 2 3 came a second agreement aimed at reducing the incentive to cheat on the newly established schedules by arranging for an allocation of traffic. The New York Central and Erie each were to carry 33 percent of the westward moving traffic, while the Pennsylvania took 25 percent, and the Baltimore & Ohio the remaining 9 percent. This time there was no opposition from Garrett. Then the presidents of these trunk lines asked Albert Fink to head the new Executive Committee of their Eastern Trunk Line Association. They proposed that he build the administrative offices necessary to carry out and enforce these agreements and to work with their western connections to do the same.

Fink was at that time managing a similar organization in the south. The southern roads differed from those north of the Potomac since there were fewer major competing roads between large cities. On the other hand, many alternative routes did exist for carrying through traffic which often moved to the seaboard ports and then by coastal steamer to New York and other northern ports. Even before the coming of the depression, these financially weak roads began to fight for the declining traffic by constant rate-cutting. At a meeting in Atlanta in 1875 a convention of southern transportation companies quickly accepted a proposal from Albert Fink, still a senior executive of the Louisville & Nashville, to set up an association or federation which would allocate traffic at points where competing roads met.’10 The allocation would be in accordance with already existing traffic patterns determined by a statistical bureau set up by the association. The presidents of the southern roads then persuaded Fink to become the first commissioner of the Southern Railway and Steamship Association.

When Fink went to work eighteen months later for the Eastern Trunk Line Association, he applied the methods he had already worked out in the south.40 His first task was to formalize regional conventions of competing roads to meet at regularly specified times to determine local as well as interregional freight rates and classifications. At the same time, he built a large staff in New York, which soon included more than sixty clerks, to collect information on existing rates and traffic movements which the committees used in their deliberations. He also held conferences on ways to adjust and enforce rate and allocation decisions and to review complaints.

Fink next brought the connecting lines to the west and to New England into the association. In the summer of 1878 the mid western roads, at Fink’s suggestion, formed the Western Executive Committee to set rates for and to allocate eastbound traffic. Then, in an agreement signed in December, the associated roads set up a Joint Executive Committee, chaired by Fink, which would give final approval of all rates worked out by the regional subcommittees or associations in the east and the west. Continuing complaints and a burst of rate-cutting drove home the need for formal cooperative action.41

According to a new agreement all cases involving rates which were not decided unanimously were to be referred to the chairman, “who shall decide the case on its merits, and whose decision shall have the same force and effect as the unanimous vote of the Committee.” Soon afterward the committee’s power was further enlarged. At the same time, a Board of Arbiters was created to listen to the complaints about Fink’s actions and to review and decide on all alleged violations of the agreement. The board was composed of three of the most able and respected railroad experts of the day: Charles Francis Adams, chairman of the Massachusetts Railroad Commission; David A. Wells, the economist; and John A. Wright, a Philadelphian who had long been a director on the Pennsylvania Railroad. For almost two years these new administrators were able to maintain the through rates on the trunk line routes.

In this way Albert Fink had by the end of 1878 created a federation of railroads which included nearly all the lines north of the Ohio and east of the Mississippi. As he reported to the Joint Executive Committee at its first annual meeting in Chicago in December 1879:

You have now for the first time established a practical method by which the competitive traffic of your roads can be properly managed and controlled. Heretofore this was impossible; the mere holding of conventions of railroad managers, passing resolutions, and then dispersing and letting things take care of themselves, each party acting as it sees fit, will not accomplish the purpose of intelligent joint management of the large property under your charge. You have now added to the legislative department—your conventions—also a permanent executive department the duty of which is to see that the resolutions passed and agreements made are faithfully carried out. In addition to this you have also established a judiciary department, consisting of a board of arbitration, whose duty it is to settle peaceably any question of difference, without resort to wasteful warfare, with all its injurious consequences. You have thus formed a complete government over this large competitive traffic over which it has heretofore been found impractical to exercise intelligent control.42

Such formal federations of railroads quickly became the order of the day. Cooperation appeared to be getting control of competition. In 1876 a number of western roads organized the Southwestern Railway Rate As- sociation with an organization copied directly from that of the Southern Railway and Steamship Association.43 John W. Midgley, formerly of the Chicago & Northeastern, became its secretary and full-time operating head. Although the new association had difficulties in carrying out its objectives, particularly after Jay Gould entered the area, other local federations were soon formed. They included the Iowa (the old “Iowa Pool” which would become in time the Western Traffic Association), the Colorado, the Texas, the Pacific Coast, and the Transcontinental Associations. Midgley soon acquired the same type of overall control of these several associations as Fink had as chairman of the Joint Executive Committee in the east. Such associations, railroad executives and experts agreed, were the only way to prevent, in Albert Fink’s words, “centralization and absorption of the roads under the absolute control of one or a few persons. It makes the separate, individual existence of these roads possible, and puts a check on the consolidation of these roads … [It] secures all the advantages of consolidation without its disadvantages.”44

Fink nevertheless feared that private federation would not in itself be able to maintain stability. To the paragraph cited above, the commissioner had added, “It must be remarked, however, that the only bond which holds this government together is the intelligence and good faith of the parties composing it.”45 He therefore urged the members of the committee and their roads to make a concerted effort to have “the operations of this committee . . . legally binding upon all parties by legislative action, provided it can be shown, as I believe it can, that its operation is beneficial to the public interests.” Yet despite an energetic campaign before congressional committees, Fink and the many other railroad managers and directors who supported this proposal failed to get the national legislature to sanction the rulings of their private associations. And they soon found to their sorrow that they could not rely on the intelligence and good faith of railroad executives, particularly entrepreneurs or speculators who like Gould had little interest in the long-term profits or operational performance of the roads whose securities they controlled.

In 1880, Jay Gould, often allied with those able stock market manipu- lators Russell Sage and Sidney Dillion, was moving swiftly to put together a transcontinental railroad empire. In the east he invaded the trunk line territory by increasing his control over the Wabash and by buying stock of the Lackawanna, the Central of New Jersey, and the Boston, New York, and Erie.46 In order to obtain traffic, Gould violated earlier agreements and provoked a passenger rate war with the Erie and the Central during the spring of 1881. Even Fink’s threat to bring all rates down to the level to which Gould had reduced them had little effect until August 1884 when a temporary armistice was finally arranged.

By this time Fink had become discouraged. As early as August 1881, he told the executive committee that: “The late events . . . have convinced me that, even with the most sincere intention, it is impractical; and that if sincerity is wanting, it is impossible to maintain the established tariff.”47 In continuing to try to make the cartel work, Fink’s organization had almost as much trouble with the weak cooperative roads (and even some of the stronger ones) as he did with the uncooperative ones controlled by speculators. Traffic managers and freight agents developed new subterfuges for evading the published rates. These included false billing regarding weight or amounts shipped or distances sent and improper classification of freight moved. To prevent such frauds Fink developed an inspection system. In 1882 the Joint Executive Committee agreed to appoint a joint agent at all places where traffic or revenue was allocated.48 This official was to have the authority to examine books and bills of lading of all member roads, while the roads and soliciting agents were deprived of any power to alter or adjust rates. The prerogative was given solely to the commissioner and his agents.

At the very time that the association was being debilitated by its failure to get the necessary cooperation from the weaker roads and those in the hands of the speculators, it was also being attacked by farmers’ granges and merchants’ boards of trade for attempting to maintain rates at artificially high levels. New York merchants continued to be angered by the rate differentials agreed upon in 1877. They argued that the rates discrimi- nated against New York in favor of the other ports. As a result, the effort of Fink and the other representatives of the railroads to legalize cartels had to encounter an ever-growing pressure to declare pooling completely illegal.

The situation failed to improve. The roads controlled by Gould and other speculators continued to maintain agreements only when it suited their immediate purposes. In 1884, with the rate structure in chaos, the association did little more than stand by helplessly. Charles Francis Adams reported of one of its meetings, “It struck me as a somewhat funereal gathering. Those comprising it were manifestly at their wit’s end .. . Mr. Fink’s great and costly organization was’all in ruins … They reminded me of men in a boat in the swift water above the rapids of Niagara.”49 A more than temporary agreement between the eastern roads was not reached until November of 1885, when the weaker companies had become exhausted. In 1886 and early 1887 the joint executive committee had little success in maintaining rates. Nor were the federations in other parts of the country doing any better.

By 1884 nearly all the railroad managers and most investors agreed that even the most carefully devised cartels were unable to control competition. They could not be relied on to assure an equitable flow of through traffic. Railroad managers continued to press for state and national legislation to legalize pooling.90 The regional associations—the Eastern Trunk Line, the Southern Steamship and Railway, the Southwestern Railway Association, and the others—continued in their efforts to set rates and classes, and they did so until the Supreme Court ruled that the Sherman Antitrust Act of 1890 had made such practices illegal. However, few railroad managers any longer expected the associations to assure them a continuing and paying flow of through traffic across their facilities. To attain this goal they turned instead, precisely as Fink had predicted, to the building of giant, self- contained interterritorial systems.

The causes for the failures of these first great cartels in the United States were many. To control and allocate the flow of traffic across the trans- portation network of a major region was a complex administrative task requiring more men and managers than Fink and his counterparts in other associations ever had at their disposal. The pooling and allocating of income, while a more modest effort, was still administratively difficult. Moreover, the roads continued to have great difficulty in determining what each considered an equitable allocation of either freight or revenue. In time of rapidly growing traffic, percentage shares agreed upon at the start of the year were outmoded by the end of the year. The more efficient roads, like the Pennsylvania, which increased their share of the traffic actually carried, resented having to pay large sums into the pool at the end of each accounting period. In addition, the activities of speculators and other businessmen who controlled the stocks of railroads for purposes of other than getting a return on their investment in transportation facilities made agreement on and enforcement of rate contracts difficult. Most important of all, however, was the relentless pressure of high constant costs. The need to meet these costs intensified the pressure to use excess capacity by subverting the cartel arrangements.

Source: Chandler Alfred D. Jr. (1977), The Visible Hand: The Managerial Revolution in American Business, Harvard University Press.

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