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Regulatory Effects on the Transportation Industry sample essay

Economic effects on freight and passenger services

Transportation Management, to the government, is the agency oversight of the movement of people and goods. That includes oversight of the economic practices of the companies that perform these services. The economic effect of such regulation is complex.

Service industries, which include the various forms of transportation of freight and passengers, are subject to a wide array of regulations. These regulations affect the economies of transportation services in differing ways. Regulations are imposed on these industries to achieve various social and economic goals. Whether they achieve these aims is a separate question. The most obvious effects of regulation are economic.

Well-crafted, appropriate regulations can be an asset both to industry and the consumer. They can move resources toward socially productive uses and away from negative ones. They can also ensure public safety and foster competition. Over regulation, however, can have the opposite effect.

Transportation, like any industry, is resistant to regulation. Evidence exists that shows the negative economic effects of regulation. Over regulation or regulations that are poorly written can unnecessarily stunt economic activity in situations where the free market could have regulated more effectively. It is up to policy makers to find a balance that achieved social aims yet allows business to thrive.

The freight transportation industry and the passenger transportation industry have some similar concerns about regulation. There are also regulations that are distinct to each industry; therefore the economic effects will likely differ. Regulation can result in a higher cost of doing business which is passed down the line to consumers. This is true in both the freight and passenger sectors.

The increased price to consumers has a ripple effect on the economy on the whole. Each sector contains complex economies, though, in which the effects of regulation may not always be clear.

Oversight-The mission, in general

Federal oversight of both the freight and passenger industries is managed by the General Services Administration. It is concerned with both regulatory cooperation and promoting the economic heath of the industries involved. The GSA works collaboratively with businesses to develop flexible regulatory policies and incentives.In both sectors, the GSA is working to smooth the process to electronic forms of transportation.

The GSA is working to support the initiatives put forward in the President’s Management Agenda (PMA). They include: the expansion of electronic government, the integration of performance and budget, strategic management of human resources and improved financial performance.

The Economic Theory of Regulation

The creation of governmental bodies to oversee and regulate certain industries has prompted efforts to measure the effects of such regulation on the overall economy. In 1971, George Stigler proposed the Economic Theory of regulation, or ET, for short.

This model measures regulatory effects on the supply chain, prices and costs, among other factors. Elements of this theory have been used to develop some of the more recent regulatory efforts. The model has since been revised.

Critics of this model argue that it is successful for academic purposes, but is incomplete in an always changing business environment. Comparing economic effects directly between the freight and passenger transportation industries is difficult because of the differing nature of regulation. Creating regulations for these industries, or removing them, is a trial and error process.

The Freight Industry

Regulation in the freight industry traditionally has focused more on business structure than in the safety and price conscious passer industry. As in passenger service, the trend in freight has been toward gradual deregulation.

Monopolistic practices have been a concern, particularly in the United States, since the beginnings of the modern transportation industry. The question is to whether assertive government regulation is better than the free markets alone for creating competition.

The Interstate Commerce Commission (ICC) was created after the Interstate Commerce Act was signed into law in 1887. This organization exercises broad regulatory powers over surface transportation industries. The ICC can not only review rates upon complaint, it can replace them with new rates.

Many passenger and freight service companies protested, or tried to evade altogether, the reach of the ICC. Regulation introduced an unnecessary variable into the theory of consumer behavior, they felt. If prices are not solely the function of demand and cost, the outcome for the business is unpredictable. Regulation, they feared, would also make market entry more difficult. Competition could be reduced and the consumer could suffer in the end.

Early actions of the ICC benefited producers of raw materials and goods. At the same time, their actions hurt manufacturer and decreased national economic efficiency. Rate manipulation by the ICC prompted factories to locate closer to final markets in order to minimize transportation costs. Railroads also challenged the ICC in court or found ways around the regulations.

Even if it is not specifically quantifiable, it is obvious that regulations affected the economy. The reverse is also true. Changes in the overall economy have prompted changes in regulation. The Great Depression and its negative effect on the rail industry prompted the appointment of a Federal Transportation Coordinator and the passage of the Motor Carrier Act of 1935.

A 1960 report by the United States Senate highlighted the effect of over regulation of the freight industry. It stated that the railroads and other transportation industries under direct federal regulation were at a distinct economic disadvantage to those that were not.

The rail industry, in particular, was unable to set competitive rates under ICC control. Meanwhile, the less regulated motor carrier industry prospered. As that industry became more regulated, efficiency began to drop. In response, deregulation of both industries began in the late 1970’s and early 1980’s.

As carriers were allowed to eliminate unprofitable activities and set their prices based on demand, revenue and investment increased. In the mid-1980’s, the ICC was replaced by the Surface Transportation Board, a regulatory agency that is reduced in size and scope.

Today’s oversight of the industry has changed in nature. Security and safety concerns are paramount after the events of 9/11. Freight carriers are incurring more expenses for security either directly because of regulation or on their own. These costs are passed down the line to consumers.

The question has arisen as to whether economic reregulation is necessary as the number of railroad companies shrinks. It appears as if that is not likely in the short term. As long as the motor carrier industry is competitive, it will serve to hold rail rates down. Market entry, however, is more difficult for railways. Opening that market may be a goal of future regulation.

Security has become a primary focus of government regulation. There is a great deal of pressure for companies to do more thorough screening of cargo and implement more stringent security practices. This will inevitably increase cost to both the industry and consumers.

The shipping industry is inherently international. Many laws exist, to protect domestic carriers and to ensure safety and security. Domestically, all goods must travel on approved U.S. flag vessels. Separate restrictions apply for HAZMAT or classified materials.

For all shipments, the shipper must check for any contracts or rate tenders that may apply. In selecting a provider, the shipper must demonstrate no preferential treatment toward any one provider. Insurance may also be required. Incentives may exist for selecting a provider that uses alternative fuels. In that sense, regulation indirectly benefits the alternative fuel industry.

The government can mandate that certain international shipments be performed by a U.S. flag carrier. Cargo preference laws regulate the international shipment of property by water. In this situation, a U.S. flag carrier must be used whenever available. Waivers can be obtained, but they must be approved in advance. The Maritime Commission is the agency that monitors compliance to these and other laws.

These laws, and similar ones by other countries, limit the amount of competition and may affect the efficiency of domestic businesses.

The Passenger Industry

Air travel is the most popular non-automotive mode of travel in the world. In recent years there has been a drive toward deregulating the industry. Service agreements have been liberalized, especially in the United States. Open Skies agreements loosen restrictions on market entry and airport usage between the U.S. and other countries.

Price and route scheduling in the air industry are for the most part deregulated but other parts of the industry are not. Deregulation of the air industry began in 1979. Since then, there has been vast growth in the industry. Competition has also increased, allaying the fears of some that monopolies would develop.

Prices, adjusted for inflation, have also fallen since the 1980’s in the United States. They have remained constant in Canada and other more regulated economies. Competition has not benefited every consumer but, on average, it has had a positive effect. Demand has increased to an all-time high, even as airlines continue to recover from the effects of 9/11.

The basic structure of the airlines has changed since deregulation. Most airlines have instituted a “hub and spoke system” in which a traveler can travel efficiently through “hub” cities to their destination. This also allows airlines a more cost-efficient organization of their fleet. As airlines eliminated non-profitable destinations, other specialty carriers have moved in to meet demand in those cities.

A significant amount of study has been done on the economic effect of regulation on the airline industry. It should be noted that determining exact cause and effect is not a straightforward process. Prices and industry efficiency are dependent on regulation and a multitude of other factors.

Profits fluctuate wildly in passenger industries. A deregulated environment is effective for such industries because the fluctuations attract new investment and can actually facilitate market entry.

The airline industry is inherently global, and regulation has global effects. In this sense, the passenger industry has to deal with economic realities that most surface freight industries do not. For example, United States regulations allow Canadian airlines to land or pick up at U.S. airports. They cannot, however, have both ends of the flight within the U.S.

This reduces competition because Canadian air cannot form a complete hub and spoke system to efficiently serve passengers. This may have the end result of raising prices for consumers in certain markets, or, it may prompt other airlines to enter in order to serve that market. In this regard, the effect of regulation is somewhat uneven and unpredictable.

Another source of regulation fro the passenger industry is the issue of foreign ownership. Theoretically, allowing foreign ownership of U.S. airlines could create more competition and lower prices. However, officials fear that allowing foreign ownership could create a situation where airlines are less accountable to regulatory power.

An emerging focus of regulation in the passenger industry is security. Many new measures affecting airlines, airports and surface carriers are in the process of being implemented. The economic effect of these measures has not been studied and is not yet well known. Some of the expense is being absorbed by the federal government, such as in the case of the federalization of airport screeners.

In the passenger ship industry, restrictions are fewer regarding international ownership and usage of U.S. ports. There is pressure on congress, however to provide greater oversight of this industry. It is unclear at this point if regulation will increase and what effect it will have on the economy of that industry.

Deregulation Theory and the Critics

In the passenger service industry, the seemingly successful deregulation of the airlines has prompted deregulation efforts in other sectors. The theory behind deregulation is simply that free markets work. Free markets will solve most of the problems that regulation seeks to remedy, as long as there is a competitive market. Demand, or lack of it, will control prices and force healthy competition.

The Herfindahl index is a measure of industry concentration in certain markets. Proponents of deregulation in the air industry, for instance, cite that the Herfindahl has remained relatively stable since the initial shake-out of firms after the 1979 deregulation. In other words, competition is healthy and the consumer is being served at reasonable prices.

Some of the effects that critics feared have apparently not come to pass. In the airline industry, research shows no significant decline in safety levels, and no decreases in service to smaller communities sine deregulation. Past experience shows that there is a negative linkage between regulation, market structure and service.

There are some concentrated markets, proponents concede, but this is not necessarily bad. Some concentration allows the airlines to create bigger, more complete networks that serve more consumers.

Regulation in both the freight and passenger industries now focuses away from business structure and price control. Regulations are more directed toward safety and security issues. Oversight in the freight industry still has a somewhat wider scope.

Deregulation is not without its critics. Some point to the power industry as an example of deregulation gone too far. In the wake of deregulation, huge entrepreneurial companies such as Enron surfaced. Monopolistic practices were ushered in, and ultimately the needs of the consumers were not fulfilled.

Deregulation proponents in the transportation industry, however, do not see this as a relevant example. The corruption at Enron was not created by deregulation, and economic factors in transportation are not the same.


The economic effects of regulation on both the freight and passenger service industries are many and varied. Difficulties exist in quantifying exact effects. Government attempts to regulate price, in particular have not always produced the intended result.

The lack of knowledge on exact economic effects of regulation can be improved upon. More comprehensive studies can be undertaken in future years to clarify how these restrictions help or hurt the economy. Sophisticated technology is in development that can replicate various scenarios, a tool officials need before attempting to write policy.

Regulations on transportation affect not only the transportation industry itself, but also any company that uses that industry. It is estimated that for the average company, transportation accounts for 3% to 7% of the total company costs. Therefore, regulation can have a significant effect on the economy as a whole.

For the individual business, regulation can have ripple effects that influence inventory control, warehousing, accounting, customer service and a host of other area. It is not necessarily a negative effect, though. Efficient business combined with well thought out policy can provide a positive result for the economy.

The way business is conducted is undergoing a rapid overhaul. New technologies are being introduced at a blinding pace. Future regulatory efforts will have to take this into account. A well-intentioned regulatory action could have the effect of slowing down a business in a climate where fastest is best.

The safety and security measures that are necessary in the 21st century will inevitably have an economic effect. The money, however, is well spent. In future years, companies with good track records on security and safety will reap the financial benefits.

For the freight and passenger industries, the trend has been toward deregulation in the economic sphere. The government will still take action if it perceives that there is a constraint on competition. It still holds veto power over large mergers, for example.

Comparison of the economic effects of regulation between the passenger and freight industries suggests that a limited regime of regulation is necessary for safety and, to a lesser extent, for the economic health of the industries themselves.

There are different regulatory focuses for each industry. What they all share is that they all produce a ripple effect that branches out to all sectors of the business, the consumer, and the larger economy. That effect can be negative, or, with well written policy, it can be positive.

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