Wages in rail markets: deregulation, mergers, and changing networks characteristics.

• Author: Davis, David E.
• Position: Illustration

1. Introduction

   Over the last 25 years, there has been significant regulatory reform in key infrastructure industries, including airlines, motor carriage, telecommunications, electricity, and railroad markets. Regulation is commonly thought to benefit labor employed in those markets (Rose 1987; Hendricks 1994; Card 1998). In such research, it is commonly held that regulation creates rents, a portion of which is appropriated by labor unions in the form of higher wages and, perhaps, employment. With deregulation, rents dissipate along with wages and possibly employment. Indeed, there is considerable evidence suggesting that deregulation reduces rents and, as a result, wages and employment have fallen in many of these industries. (1) However, as noted by Hendricks (1977, 1994), the effects of regulation and deregulation are market specific and depend critically on the regulatory process. Indeed, unlike other industries, partial deregulation of the railroad industry likely reduced inefficiencies and increased the level of rents available. (2)

   In our previous study, we found that employment levels have decreased due to partial deregulation, mergers, and changing operating and network characteristics of firms (Davis and Wilson 1999). In this study, we examine average hourly earnings (total per hour compensation) for railroad workers and partial deregulation, finding that compensation rates have increased dramatically despite large decreases in employment. One hypothesis for this finding is that, under regulation, there were serious inefficiencies embedded in the industry, some of which were directly related to labor (e.g., inefficient work rules) while still other inefficiencies affected rail labor. (3) Under partial deregulation, both labor and regulatory impediments to efficiency were reduced, increasing labor productivity and resulting in the loss of employed labor. Thus, partial deregulation may have allowed for increased rents, some of which were shared with the labor that remains.

   Partial deregulation of the railroad industry by the Staggers Act of 1980 allowed firms greater freedom to adjust rates, to merge with other firms, and to abandon or sell unprofitable lines. These freedoms allowed firms to change the structure of the industry and to alter their operating characteristics. There is now quite a lot of research on rates and costs in the industry resulting from these freedoms. (4) Generally, it is now widely held that costs have fallen dramatically as a result of partial deregulation and that rates are much lower due to partial deregulation, costs savings, and changes in the network and operating characteristics of firms.

   Since partial deregulation, there have been associated and major effects on labor in the industry. From 1978 to 1994, industry employment decreased by 60%, while average firm employment increased by 33%. Accompanying these changes are a 43% increase in real average compensation and a reduction in the number of firms from 41 in 1978 to 12 in 1994 (American Association of Railroads, 1983-1994). The contraction of firms is largely the result of a massive consolidation movement since partial deregulation. Many studies have documented how partial deregulation affected industry costs, efficiency, and profits. Some studies have also examined the effects of these changes on the industry's labor markets (Hendricks 1994; MacDonald and Cavalluzzo 1996; Peoples 1998). Generally, these studies use either aggregate wage data or Consumer Population Survey data, which do not allow characteristics of the firm(s) to be embedded in the estimation. In this research, we extend previous research by identifying industry and firm-le vel variables, directly or indirectly associated with partial deregulation, that affect firm-level wages. These variables allow the effects of mergers, partial deregulation, and changes in firm characteristics/networks to be empirically identified. We find that mergers generally result in higher compensation, with an average marginal effect ranging from 7.5 to 15%, and that mergers contribute 5 to 15% of the overall increase in wages. Our estimates suggest partial deregulation accounts for about 20 to 23% of the increase in average compensation between 1978 and 1994. We find evidence that firm operating characteristics matter in the determination of average compensation. In particular, output, size of network, average length of haul, and the percentage of unit train traffic (i.e., bulk movements) each have effects on average compensation.

2. Background

   Through the range of our data (described below), all firms with the exception of the Florida East Coast were governed by union work rules. Faced with coordinating a large industrial enterprise with workers who were often inexperienced and undisciplined, early railroads developed a system of stringent and well-defined work rules. Subsequently, these work rules became, and remain, a central feature of railroad negotiations with unions. (5) These work rules govern the type of work that members do and dictate the number of workers in many jobs. Work rules mandate the number of crew members required to operate a train (Peoples 1998; Talley 2001). Work rules have also established the number of miles a train must travel to constitute a full workday (Peoples 1998; Talley 2001). Historically, unions have seen work rules as tools for maintaining job security, while firms have seen them as costly impediments to productivity.

   Many studies have examined the impact of deregulation for unionized labor markets. Hendricks (1994) offers a concise description of several mechanisms that may be at work in regulated markets. He suggests that deregulation can have contrasting effects. For example, deregulation may introduce increased competition between firms, decreasing prices, and put downward pressure on wages. At the same time, deregulation may allow management a more efficient use of labor, increasing labor productivity. Improvements in productivity may be associated with increases in wages. In his study, Hendricks finds that, on average, rail earnings were positive relative to other manufacturing industries before and after deregulation. However, this differential vanished when worker characteristics and union density were included as explanatory variables in an earnings regression. Furthermore, Hendrick's plots of annual observations on rail earnings differentials suggest differentials were higher in the early 1980s than in the later 1980s.

   MacDonald and Cavalluzzo (1996) examine railroad wages and regulation and find that rail wages followed a complex pattern after partial deregulation. The authors find that wage premiums initially increased after partial deregulation as unions successfully bargained for higher wages. The authors suggest that firms and unions expected increased profits after partial deregulation as firms were expected to raise rates. However, as firms customized their rates to conform to the cost structure of shipments, traffic shifted, labor demand fell, and negotiations turned less favorable to unions. Other researchers explicitly examine labor productivity in the railroad industry. Hsing and Mixon (1995) find that labor productivity accelerated after partial deregulation. They also suggest that employment become more wage elastic after partial deregulation. These results suggest that large employment declines should be associated with relatively small wage increases.

   Present in these studies is the notion that partial deregulation allowed firms the freedom to adapt, to change or avoid work rules, and to respond to competition from other modes of transportation. For example, partial deregulation allowed firms unprecedented freedom to customize rate structures. Adjusting rates allowed firms to offer shippers incentives enticing them to consolidate shipments over longer distances in labor-saving unit trains, which allowed railroads to exploit unrealized economies of traffic density and service. (6) Mergers between firms, whether parallel or end-to-end, allowed for a more efficient network of track and improvements in efficiency and traffic density. Furthermore, partial deregulation allowed firms unprecedented freedom to abandon high-cost lines, again allowing for a more efficient track network.

   These changes clearly affected labor, as several industry characteristics, especially employment, changed dramatically after partial deregulation. Total industry output increased modestly, and employment fell dramatically, translating into large increases in labor productivity (see Table 1). In the unionized railroad industry, the relationship between labor productivity and wages is not straightforward. Regulation required firms to service a number of unprofitable lines, and work rules maintained employment levels arguably higher than the efficient level. If, in addition, unions kept wages artificially high, partial deregulation may have simply allowed firms to improve productivity to match wages. In this study, we investigate the magnitude and direction of the relationship between real compensation and firm characteristics associated with partial deregulation and labor productivity. (7)

3. Model

   To model firm wages in this industry, we follow Martinello (1989), wherein firms minimize costs, subject to a union utility constraint. The firm's minimum nonlabor cost function is (i.e., the cost function given a level of employment)

   K(r,Q | L) = [min.sub.x][rX | L] s.t. Q = Q(X,L), (1)

   where L = employment, X = a vector of inputs, r is a vector of input prices, Q is a vector of output, and Q(X, L) is the technology. Unions derive utility from wages and employment, U = U(w, L). We assume unions require wages sufficient to provide a level of utility superior to the level of utility received in alternative opportunities, U(w, L) = [theta]U([w.sub.a], L). Inverting this utility function allows L to be expressed in terms of the alternative...