The

for rate regulation so far at least as the general rate schedule is concerned. But as a matter of fact the field of active competition in transportation rates is limited. It is well known that rate schedules are agreed upon at conferences of representatives of the so-called competing roads. Following the example of Massachusetts in 1882, the New England states, New York and more recently a few other states have practically recognized the essentially monopolistic character of railroad transportation and the disadvantage of unnecessary competition, by requiring an official certification of "public convenienceand necessity" for the construction of a new road. only reason that can justify the building of a parallel competing road under present policies of public control over rates and service, is that the existing road cannot be induced to provide adequate facilities. Under the old régime of pseudo competition and no public control the promoter of a competing road had no legitimate reason for his venture unless he considered that the new road could draw sufficient traffic at remunerative rates from the existing road to permit it to earn a fair return on its investment. He certainly had no right to assume, however, that the rates of a competing and more favorably situated line would be raised in order to permit the new road to earn a fair return. Under a régime of actual competition rates would certainly not be based on the cost to the most inefficient and expensively constructed competitor. This, however, is apparently the theory that the advocates of a market value standard would apply to the determination of rates under a system of public control.

§ 55. Favorable location in its relation to market value theory. Favorable location also adds to fair value for rate purposes under the market value theory. A railroad has selected for itself the most favorable locations for its road.

and terminals. Perhaps it follows the only available route through a narrow pass or valley and has terminals monopolizing the most favorable locations. Some conceptions of the market value theory would capitalize all such monopolistic advantages arising from favorable location. It is argued that any competitor would have less traffic and would necessarily have to spend more for construction, more for operation, and much more per unit of traffic. Rates charged by such a competitor to be remunerative would necessarily have to be correspondingly high. It is argued that remunerative rates for this possible competitor should serve to fix the rates of the existing road. The net returns under rates thus fixed will be capitalized to fix the market value and this market value may be greatly in excess of either the actual cost or the cost of reproduction. But by this method the rates are determined before the market value is found and therefore the determination of market value is in fact unnecessary. Market value is determined by income under reasonable rates, and reasonable rates are determined in either of two ways: (1) If the reproduction cost or expense of operation is less than that of an actually competing or hypothetically competing line, by such rates as will give a fair return on the cost of such competing or hypothetical line. (2) If the reproduction cost or expense of operation is equal to or greater than that of an actually competing or hypothetically competing line, by a fair return on such reproduction cost. In this latter case the cost and the market value are identical.

$56. Monopoly value.

The monopoly value arising from favorable location is not usually claimed for utilities other than railroads. It is somewhat similar to the claim that location in the city streets under a franchise can be capitalized for rate

valuation purposes. A closer parallel, however, is the case of a water supply plant that has secured the most economical source of supply. Any competing company would have to obtain a supply from a much more distant source, thus greatly increasing the capital cost. It has been claimed that in a rate case the fair value of the water plant is not its cost but the greater cost of the new plant. This claim was denied by District Judge Farrington in his opinion in Spring Valley Water Works v. San Francisco, 192 Fed. 137, decided October 21, 1911 (quoted below, § 78). It is inconsistent with what is believed to be the governing principle of justice and equity which forms the basis of public service control, that rates should be increased in order to pay a return on the capitalized value of exclusive location or other monopoly advantage that represents no actual investment. A railroad exercises the right of eminent domain to secure its location and the right of eminent domain can only be lawfully exercised for a public purpose. The location secured by this method for a public purpose cannot justly create a monopoly that will be capitalized against the very public purpose that it was intended to serve-the transportation of freight and pas

sengers.

§ 57. Reasonable rates cannot be based on market value. By the above method rates are based on physical cost, but not necessarily on the cost of the road itself, but in many cases on the cost of a competing or hypothetical road. Market value has nothing to do with the rate question as thus considered. It is only set up after the rates are in fact determined. To be sure, the theory is that rates are based on a fair return on the market value of the road under reasonable rates. The impossibility of basing reasonable rates on a market value that is itself determined by reasonable rates is apparent. It is a clear

case of reasoning in a circle. We have the evident absurdity of requiring the answer to the problem before we can undertake its solution. The advocates of the market value theory cannot really mean what they say. Market value is not really a part of the process but the final result. It includes in many cases a capitalization of certain monopoly profits and the monopoly value thus created is set up as justifying the higher rates which have in fact created the monopoly value. A difficulty in the consistent application of the market value theory is illustrated by the following: The Washington Railroad Commission determines the present cash market value of the railroad (see § 52) and then fixes rates so as to allow the company to earn a return of 7% (see § 769) on this marlt value. The query is whether this determination does immediately create a new and higher cash market value therefore require an immediate increase in the rates. established. This will be true if the capitalization rate I actually determines market value is lower than 7%. If, for example, the capital of the railroad in question consists of two-thirds bonds and one-third stock, and if the 5% bonds sell at par and the stock can be sold on a 7% income basis, then the present cash market value of this road will be increased under the rates and rate of return fixed about 17% above the "present cash market value" fixed by the Commission.

B

§ 58. The misplaced or partially obsolete plant.

While it is clear that market value as above considered is not a proper general standard of value for rate purposes it is possible that it may have some merit in the valuation of a misplaced or partially obsolete plant. This is referred to the report of Commissioner Lawrence of the Washington Railroad Commission above quoted (§ 51) and is also discussed in the report of the Valuation Committee

of the National Association of Railroad Commissioners, in October, 1911, as follows: 4

The misplaced or partially obsolete plant or road is the one that causes greatest difficulty in valuations for any purpose. A waterworks plant has been built for a village too small to support it and the population of the village instead of increasing as expected actually decreases. A railroad has been constructed chiefly to carry coal from certain mines or lumber from a certain district. The coal or the timber becomes exhausted leaving a railroad that cannot pay a fair return on its actual cost or its reproduction cost no matter what the scale of rates charged. A street railway is constructed chiefly to carry passengers to a certain terminal, but currents of travel having changed, it can not possibly earn interest on its actual cost. Under such conditions the plant or line as a whole must be recognized as partially obsolete, and the best gauge of its present depreciated value will in many cases be its fair market value. Cases of this kind are frequently met with in valuation for tax purposes. A general reduction in the rates of a road or plant of this kind seldom comes up for official consideration but it very frequently happens in valuing any comprehensive railroad or street railway system for rate purposes, that there are certain lines that are partially obsolete though the system as a whole is earning a profit. For such partially obsolete, or partially used lines, neither actual cost nor reproduction cost, nor reproduction cost less existing physical depreciation, furnish any basis for fixing fair value for rate purposes. The value that will be most appropriate will be a value based on the earnings of the line as a part of the system and will thus be closely related to market or commercial value. But though in a rate case we can, as above, base the value of a particular part of a comprehensive system on earnings or market value, we can not base the value of the whole system on market value, as the market value depends on the scale of rates charged, and the rate scale is the question at

National Association of Railway Commissioners, Proceedings of the Twenty-third Annual Convention, October, 1911, p. 148.