Opinion ID: 403665
Heading Depth: 2
Heading Rank: 2

Heading: Adoption of the Modified AAR Index

Text: 10 The Commission's search for an index that would properly measure inflationary cost increases preceded the enactment of the Staggers Act. On April 22, 1980, the Commission issued an Advance Notice of Proposed Rulemaking in Ex Parte No. 290 (Sub. No. 2), Railroad Cost Recovery Procedures soliciting suggestions for measuring average cost increases for railroads. The Commission explained that it wished to establish a mechanism by which railroads could recover increased costs without being subjected to the length and uncertainty of individualized rate proceedings. See 45 Fed.Reg. 29,103-04 (1980); Joint Appendix (J.A.) 42-43. In response, the Commission received extensive comments from railroads, shippers, and purchasers of commodities shipped by rail. The railroads proposed that the Commission adopt the Association of American Railroad's (AAR) index of rail costs. See Verified Statement of Dr. Paul O. Roberts & Dr. Brian C. Kullman, J.A. 52; Verified Statement of Dr. Harvey A. Levine, J.A. 420-24; Verified Statement of Mary Maher, J.A. 431-40. The shippers did not propose a specific cost index. They did suggest, however, that if the Commission adopted the AAR index it should adjust that index so that it would reflect cost savings from productivity gains. See Verified Statement of Leroy E. Peabody, Jr., J.A. 389-400. 11 The AAR index is a classic Laspeyre's price index, 8 which measures the changing cost of buying a fixed market basket of items purchased by the railroad industry. AAR selected items for the index's market basket on the basis of surveys of purchases by major railroads. The index includes 65 items that AAR found to be widely purchased in large quantities and whose price trends follow those of related materials. See Verified Statement of Mary Maher, J.A. 434. AAR updates the index's market basket periodically to reflect shifts in the typical railroad market basket. In the past, this updating has occurred every six to ten years. See id., J.A. 441. 9 12 At the heart of the shippers' criticism of the AAR index was the difference between the prices railroads pay to purchase inputs (such as labor and materials) and the costs they incur in producing their output (rail service). The shippers argued that a proper measure of railroad costs must account for the possibility that productivity gains allow railroads to produce more rail service with the same market basket of railroad inputs. By accounting for these gains, they suggested that an input index (such as the AAR index) could and should be converted into an output index-namely an index of cost per unit of output. 10 13 Before the Commission completed its proceedings on inflationary rate adjustments, Congress passed the Staggers Act. Section 203 of the Act requires the Commission to develop or verify an inflationary cost index with appropriate adjustments to reflect the changing composition of railroad costs, including the quality and mix of material and labor .... 49 U.S.C.A. § 10707a(a)(2)(B) (West Supp.1981). In accordance with this mandate, the Commission issued a new Notice of Proposed Rulemaking in Ex Parte No. 290 (Sub. No. 2), 45 Fed.Reg. 81,217 (Dec. 10, 1980); J.A. 587-99. In this notice, the Commission stated that it found the most acceptable measure of inflation for (its) purposes to be the AAR input price index, as modified by the Commission. J.A. 589. 11 The Commission stated its intention to review the statistical validity of the AAR index, check for data errors, 12 and compare the index with other data sources. But the Commission rejected the suggestion that the index should be modified to reflect productivity gains. While it acknowledged the theoretical validity of the shippers' argument that productivity gains tend to offset the upward pressure of input prices on overall rail costs, it concluded that several considerations counseled against adoption of such an index. J.A. 591. First, it found that there is no acceptable measure of productivity available to convert an input index into an output index. Second, it noted that competition among railroads ought to curb price increases caused by an inflated cost index. Third, the Commission expressed its concern that downward adjustments for productivity gains would act as a disincentive to productivity growth. J.A. 591-92. 14 Following further comments, the Commission issued a final rule adopting the modified AAR index as initially proposed. See 364 I.C.C. 841 (1981); J.A. 928. In the explanation accompanying this rule, the Commission reexamined its original rationale for not adjusting the AAR index to reflect productivity gains. First, the Commission conceded that methodological problems do not pose an absolute bar to developing measures of productivity; but it noted that these problems were nonetheless grave. See id. at 846; J.A. 931. As to the effect of a productivity deflator on incentives for productivity growth, the Commission stated its agreement with the shippers that an adjustment reflecting average productivity trends would not eliminate all incentives for individual railroads to maximize their own productivity gains. Id. at 847-48; J.A. 931-32. But the Commission said that this argument cuts two ways. While the incentive to achieve better than average productivity gains remains, those railroads that are unable to meet the industry's average performance would be unable to recover (through non-reviewable rate increases) the full measure of their inflation-induced increased costs. Finally, the Commission expressed its skepticism that, even if rates were set by competitive forces, productivity gains would be passed along to consumers. It reasoned that under competitive conditions, firms must retain revenues from cost savings if they are earning insufficient revenues to cover costs. Because it had elsewhere found that the rail industry typically earns inadequate revenues to cover economic costs, it concluded that it would be inappropriate to pass along productivity-related savings. Id. In summation, the Commission stated that as long as the railroad industry continues to earn inadequate revenues, it would not adjust the AAR input index to reflect productivity. Id.