have a right to annul the charter, andprovided it made a proper adjustment of existing investments-give it to some one else who would.

The grant of privileges to a railway is comparable to the general right of private property in land granted by society to its members. Society does this, because it expects, in spite of minor disadvantages, to gain more by giving men rights of private property than it would by not doing so. When a man buys land for a farm, he expects to enjoy the unearned increment arising from the growth of population and an increased demand for his products. All citizens alike have that right at present. The proposal to take away this unearned increment from the land-owner has never been given serious consideration, both because of difficulties as to valuation, and because it would render the state liable for losses, if it took away gains. Now, how does this general attitude toward private property apply to a railway? If it is expected to make a large initial outlay, at a risk as to future profit-and not all railways by any means are financial successes -shall its property be deprived of those gains due to the growth of population and wealth which is enjoyed by all other owners of property? What is there in the nature of transportation which sets it apart from other industries in its relation to property rights?

A railway, as well as a farmer, invests private capital in a fixed form and locality, in order to obtain income. So far as either of these does not interfere with the rights of others, their economic position before the state is much the same. The quasi-public nature of a railway justifies public regulation to insure equal treatment for all; but it is also true that if a farmer trespasses on the public roads, or keeps a nuisance, he would likewise be subject to regulation. Therefore, keeping strictly to a general principle of justice, is there any more reason for taking away the unearned increment from a railway than from a farmer? If an increase of numbers and wealth increases the income, and so the value, of a farmer's land, would it be just to make an inventory merely of the capital he invested, and take away from him all his gains due to society at large? Beyond proportional taxation on an increased valu

ation, who else has a better claim to the unearned increment? And this, by the way, says nothing as to returns due to the farmer's skill and foresight. In truth, are not millions of farmers to-day moving out on to the cheap land of the West and Southwest, paying low prices per acre, solely because they expect to enjoy the coming unearned increment? Is this proposal to take away the earnings of railways due to franchises any less academic than the whole question of taxing out of existence the unearned increment from land? If, then, it is an impracticable scheme as regards the farmer and land-owners in general, why should it be enforced upon one special kind of property created by society in the form of a railway?

Now that the hysterics manufactured for consumption in a presidential campaign are exhausted, we should be able to discuss these matters sanely. So far as they affect his property, a farmer is allowed to enjoy, sell, or capitalize the results due to the growth of the country. If so, then why should not a railway have an equal right? Yet, there are those who declare that the act of giving a charter by the public to a company to build a railway carries with it the exclusion of all claim to future income derived from the growth of the country. This is what is meant by saying that earnings from franchises should be eliminated in arriving at the true basis of valuation of a railway.* Provided that a railway gives prompt and efficient service, at reasonable rates, and equal treatment to all, it has made the returns to society that were expected when the charter was granted; and for the rest should it not stand on the same ground as other property, so long as the institution of private property remains the essential basis of our economic and civil existence? When the Pennsylvania Railway invests $100,000,000 in tunnels and terminals in New York, it takes the same risks for the future-in kind, although not in degree-that a farmer takes when he builds a large new barn. Why should not both have the unearned increment?

*This should not be the same thing as letting a piece of property on which a rental is paid. In a municipality the renting of the space in the streets for street railways is to be paid for by the renting company that occupies the streets. The streets belong to the municipality, but the right of way of a railway has been bought from private owners, and in cases of condemnation, even then it is bought from private owners, although the price is legally adjusted.

As regards the growth of the country, moreover, it is well known that, to meet the new demands for traffic, railways had to be practically rebuilt, with larger and very expensive terminals, heavier rolling-stock, longer and more side-tracks, and the like. In short, the growth of the country has, of necessity, brought about an enormous increase of the capital investment, as to reasonable returns on which there is no dispute. Now, in general, it is the line which has the best road-bed and equipment that can most easily obtain the needed capital for improvements, thus enabling it to reduce grades and lower rates on an increasing density of traffic. Thus the rates happen to vary in inverse relation to the valuation.

Whether we have in mind a farm, an industry, or a railway, there is another source of earnings which plays a very important part-one, too, which is independent of franchises. Managerial ability is often the chief item in bringing out earnings from any kind of venture, and it appears preeminently in the earnings of railways. There is here no intention of overlooking the cheating and unprincipled operations of railway manipulators. Their work stands in a class by itself; just as highwaymen are different from industrious farmers. The existence of sharks in railway operations does not argue the nonexistence of the entrepreneurs who are far-sighted, square, skilful, judicious, and careful of their responsibilities to the public.

The latter are not to be overlooked because of the greater notoriety gained by rascals in their own profession. In a railway, as in a great industrial plant, the organizing ability of a successful manager has often justly built up a continuing efficiency in his system which goes on when he leaves it; he has introduced new methods and shown the best way to others; and the results of his good management continue to add to the income in the future because they have been worked out to suit the needs and convenience of the public served by that particular railway. If this efficiency created by a manager in an organization is a permanent addition to the utility of the transportation instrument, it is a regular source of increased earningsthe same, in effect, as an addition to the sources of income arising from any other

admitted factor in production. Since these results of management have become a constituent part of the whole transportation machine, it is as much to be regarded as a source of earnings as anything else, such as capital. For capital in and by itself is as inert without skilful management as labor would be without capital. Therefore, if good management is a source of earnings, the valuation based on such income should as legitimately be bought and sold, either in the form of securities or otherwise, as any machine-like a harvester-which results from the brain of an inventor. Consequently, we are obliged to realize that there enters in an important manner into the earnings of a railway skill of management—a factor separate from, and in addition to, the operation of franchises; and the returns from this managerial function are distinct from those chargeable either to franchises or to capital pure and simple. And if it be said that the earnings of a railway depend upon "good-will," "established connections and contracts," does it mean anything more than that they are due to managerial skill?

That other things than tangible property and franchises seriously influence the earnings and the valuation of a railway may be seen by reference to well-known facts. One railway, with efficient management and farsightedness, gains large returns, puts part of the earnings into improvements, and can carry an increased capitalization with ease. Another railway, with poor management, has low returns, and can scarcely carry its original capitalization. If both started out with the same investment, in course of time the one will have a higher physical valuation due to improvements than the other; and yet both roads, competing at the same terminals, are obliged to charge the same rates. The failure to introduce all the necessary factors affecting earnings evidently accounts for the theory which supposes that, after having subtracted the earnings of tangible property, or invested capital, from total earnings, the result is assignable solely to franchises One omission, at least, is the earnings of management. How important they are may be noticed in the particular instance of the Atchison, Topeka and Santa Fé Railway. Several times it had become bankrupt and gone through reorganizations.

Finally, the plan was adopted of securing the services of four of the best railway men to be found in the country. It is now a fact well known to the investing world that the Santa Fé system, under the leadership of Mr. E. P. Ripley and his associates, has so increased its permanent earning power that the valuation of the property has increased by hundreds of millions of dollars. Nor can this be ascribed either to franchises or to the unaided growth of the country; those causes were at work when the road was paying little income. The real cause of the change was the policy of the management in first putting the line in good physical condition, so that low rates were possible; the activity of the officials in building up industries, and developing the country through which the railway passed; and this aided, reflexively, in settling up new territory. Then, when a part of the country became well occupied-as in Kansas-for the very reason that the railway was rendering prompt and efficient service at reasonable rates, all kinds of industries ancillary to a civilized population sprang up and increased the density of the traffic. If transportation had been confined to prairie schooners, such growth would have been impossible. The railway is as much the cause of the growth of the country as the growth of the country is the cause of the growth of traffic.

IV

In the proposal to make a valuation of railways for the purposes of preventing over-capitalization, and also of controlling rates so that dividends can be paid only on invested capital, two kinds of valuation, as already mentioned, have been discussed: (1) a commercial valuation, based on earnings; and (2) a physical valuation based on an inventory of tangible property.

In respect to the commercial valuation, made in 1904 by the Bureau of the Census,* net earnings (gross earnings minus operating expenses) were used as a basis of capitalization. The rate of capitalization was obtained by dividing the corporate net income by the aggregate value of corporate securities. The commercial valuation is a market estimate which takes into consider

Bulletin 21, Department of Commerce and Labor, "Commercial Valuation of Railway Operating Property in the United States: 1904.

ation the expectation of income arising from the use of the property and its strategic significance; the growth of the country; restrictive legislation; potential competition by rail and waterways, and investment demand. Since net earnings are directly dependent on rates, and the valuation depends on net earnings, obviously such a valuation could not be used as a means of deciding upon the rates charged. The new proposals reject commercial valuation because it includes sources of earnings from franchises, and not merely from the capital invested in transportation. That is, this method of valuation is rejected because it does not conform to the assumption that a railway should not retain earnings derived from so-called franchises, the growth of the country, and the like.

On the other hand, a physical valuation is declared to be a means of governing the rates charged. Omitting franchises, the value of each form of railway property is estimated according to its cost and its length of life, and an inventory is made of the tangible railway investment in real estate, cuts, fills, bridges, ferryboats, wharves, terminals, stations, rails, ties, poles, rollingstock, and the like. Hence, the new policy which seems to have been supported by President Roosevelt proposes, if we understand it rightly, to exclude all factors in creating earnings except capital. In the first place, such a method excludes from railway property the gains from the growth of the country. It is the theory of Henry George applied to railways only, although not applied to other owners of property. In the second place, it excludes the earnings due to managerial skill. In the third place, such a valuation in fact seems to have no direct relation to rates, for the very good reason that the capital is not the sole source of earnings. Finally, the attempt to trace the value of an article, like a railway, solely to one factor in production, separate from others, is an example of questionable economic reasoning. It is impossible to separate the results in a finished product due to distinct factors, like labor or capital, which are both necessary to the output. In a coat made jointly by a man and a sewing-machine, it is impossible to draw a line across it and say that so much was due to the man and so much to

the capital invested in the machine. The value of a finished article is due to the operation of all the factors necessary to production working together. This gives the ground for claiming that a car, a locomotive, or a piece of track has in and for itself little or no value in isolation, and that their value arises from joint use in a complicated carrying instrument.

These objections make clear the reason why the opponents of a physical valuation are able to show in ordinary railway practice such evident independence of rates from such a valuation. For instance, it is well known that the rate on wheat from Dakota must be low enough to cause it to move to the central market; in other words, the price of wheat in Liverpool has more influence upon the rate than the amount of the capitalization. Moreover, wherever there is competition of goods with goods, or competition of carrying companies by rail or water with each other, the physical valuation has no effect on rates. Quite irrespective of capitalization, the railways eagerly compete for traffic. Indeed, it is the insolvent roads which offer to carry freight at the lowest rates; and the wellmanaged road must meet this cut-throat competition without regard to its invested. capital. Without doubt, all the recent exasperation against discriminations arises from the bitterness of the struggle to get traffic, wholly without any connection between the physical valuations of the rival roads. Consequently, it is clear why Hon. Martin A. Knapp, Chairman of the Interstate Commerce Commission, testified before the Industrial Commission that he had not known an instance in which rates seemed much to depend upon the capitalization of a road.

low; and yet the former might not begin to earn as much as the latter. In fact, both roads would probably charge the same rates, if in a competitive territory. The one may be a more valuable road than the other because of the density of traffic and obtain larger earnings quite irrespective of its lower physical valuation. Certainly, there are so many instances in which the physical valuation can have no relation to rates that it can hardly be seriously used as a means of regulating such rates.

The conditions which work upon rates are many and diverse, such as activity or depression of trade; the competition of goods with goods; the competition in international markets; the probability of obtaining future traffic by opening up new districts; the rivalry of different cities and interests. In many cases the rate is fixed for the railway by conditions beyond its control and it has no option but to accept. For example, lumber from the Pacific States must be given a rate to Chicago low enough to enable it to compete with lumber from nearby states; otherwise the traffic would not be moved. This is one case in which the railway can charge only what the traffic will bear.

The railway opponents of a physical valuation are able to point out* that a small railroad in Pennsylvania earned $25,000 in 1905, but in 1906, because of the building of a parallel road, it showed a loss of $10,000. In another instance, the Cincinnati, Lebanon and Northern Railway in the suburbs of Cincinnati earned nothing; but after being sold to the Pennsylvania Company, it was placed on a dividend-paying basis.

As regards over-capitalization, the case is closely connected with that of rates already discussed. Sometimes, as in the plundering of the Chicago and Alton, it is believed that a higher capitalization will be a reason for high rates: but this is seldom the case in practice. The over-capitalization of railways is chiefly a matter concerning the railway and the investor, and has little to do with rates. Since to the investor

and in the case of bankruptcy, to the customer of the railway-it is a danger to have his securities reduced in value by over-capitalization, the wrong should be avoided by more direct and efficient means *I. L. Lee, "Railroad Valuation," Bankers' Magazine,