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The Timing of Railway Construction on the Canadian Prairies Author(syf ) U D Q N ' / H Z L V D Q G ' D Y L G 5 5 R E L Q V R n Source: The Canadian Journal of Economics / Revue canadienne d'Economique, Vol. 17, No. 2 (May, 1984yf S S 2 Published by: Wiley on behalf of the Canadian Economics Association Stable URL: http://www.jstor.org/stable/134961 Accessed: 01-03-2017 19:21 UTC JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact [email protected]. Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at http://about.jstor.org/terms Canadian Economics Association, Wiley are collaborating with JSTOR to digitize, preserve and extend access to The Canadian Journal of Economics / Revue canadienne d'Economique This content downloaded from 142.104.160.247 on Wed, 01 Mar 2017 19:21:49 UTC All use subject to http://about.jstor.org/terms The timing of railway construction on the Canadian Prairies FRANK D. LEWISand DAVID R. ROBINSON/ Queen's University Abstract. It is generally agreed that railways were a prerequisite to the Canadian 'wheat boom.' In this paper we analyse the timing of railway construction in south-eastern Saskatchewan during the wheat boom period. A monopoly model is derived in which a railway makes its construction and pricing decisions on the basis of a rational settler's response function. Between 1898 and 1906, when the CPR had a monopoly, the model closely predicts freight rates and the timing of branch line completions. The increase in branch line construction after 1898 is explained partly by the decline in the railway's operating cost and partly by the Crow's Nest Pass Agreement. This agreement raised the value of CPR land by setting long-term ceilings on freight rates. Le moment approprie pour la construction du chemin defer dans les prairies canadiennes. On est generalement d'accord pour dire que les chemins de fer ont ete une condition necessaire pour le boom du ble. Dans ce memoire, les auteurs analysent les decisions quant au moment de la construction des chemins de fer dans le sud-est de la Saskatchewan au cours de la periode du boom du ble. Ils derivent un modele de monopole dans lequel la compagnie de chemin de fer prend ses decisions quant a la construction et quant 'a la tarification sur la base d'une fonction de reaction des colons rationnels. Entre 1898 et 1906, la periode de monopole du CPR, le modele permet de predire 'a quel moment on devrait completer la construction de certaines lignes secondaires et quelle devrait etre la tarification. L'acceleration de la construction des lignes secondaires apres 1898 est attribuable en partie a la chute dans les couits d'operation du CPR et en partie a I'Accord des tarifs du Nid de Corbeau. Cet accord elevait la valeur des terres du CPR en imposant un plafond 'a long terme sur les tarifs. INTRODUCTION Economic historians have long been puzzled by the timing of Canadian prairie settlement. The Canadian Pacific Railway's transcontinental line was completed in 1885, eleven years before the beginning of the 'wheat boom'; and it was not until after 1900 that there was large-scale settlement west of the Manitoba-Saskatchewan border. In a series of recent articles economic historians have tried to explain this lag, For their helpful comments we thank Alan Green, Knick Harley, Marvin McInnis, and Gillian Wogin. An earlier version of this paper was presented to the Twelfth Conference on Quantitative Methods in Canadian Economic History at Edmonton, 1982. Canadian Journal of Economics / Revue canadienne d'Economique XVII, No. 2 May / mai 1984. Printed in Canada / Imprime au Canada 0008-4085 / 84 / 340-352 $01.50 ?yf & D Q D G L D Q ( F R Q R P L F V $ V V R F L D W L R n This content downloaded from 142.104.160.247 on Wed, 01 Mar 2017 19:21:49 UTC All use subject to http://about.jstor.org/terms The timing of railway construction / 341 and although no consensus has emerged on the causes of settlement, progress has been made. Marr and Percy (1978yf S R L Q W W R O D U J H H [ S H Q G L W X U H V E \ W K H & D Q D G L D n government to promote immigration and to the increase in railroad mileage. Norrie (1980yf I L Q G V U D S L G G L I I X V L R Q R I G U \ I D U P L Q J W H F K Q L T X H V D Q G ' L F N \f estimates a gradual decline in the cost per acre of growing wheat. In another recent paper, Lewis (1981yf G H Y H O R S V D V L P X O D W L R Q P R G H O R I S U D L U L H V H W W O H P H Q W + H I L Q G V W K D W V H W W O H P H Q t advanced with the feasible region of wheat cultivation, the area on which wheat farming was profitable.' Increasing mean wheat yields accounts in part for the extension of the feasible region, but it is the construction of railway branch lines that has by far the larger impact. In all these papers, settlement is analysed on the basis of an exogenously given rail network. Missing is an account of the railway's decision to construct lines. To fill this gap we develop a model that recognizes explicitly the interdependence of the railway's and settlers' decisions and treats the timing of railroad construction as endogenous. At the heart of our model is the hypothesis that railway companies know the response function of settlers. The firms, therefore, base their construction decision not on observed settlement but rather on their estimate of future settlement conditional on a rail line being completed.2 We apply our model to south-eastern Saskatchewan during a period when there was no interrailway competition - the CPR had a monopoly - and implement the notion of a settler's response function by using a simplified vesion of the Lewis (1981yf P R G H O Z K L F K K H W H V W H G R Q W K H V D P H U H J L R Q . We begin by outlining briefly the pattern of early railway construction in south-eastern Saskatchewan. In addition to the transcontinental line, the CPR completed two lines prior to 1900: a branch from Moose Jaw to North Portal on the u.s. border and a section that connected Esteven and Souris, Manitoba (see figure 1yf . Neither of these lines, however, can be explained on the basis of locally generated traffic. They were through lines designed to provide a connection to the u.s. market in Chicago. Two colonization railroads that passed through the region also were completed before 1900: the Qu'Appelle Long Lake and Saskatchewan Railway (QLLyf that extended north from Regina to Prince Albert, and the Manitoba and North Western Railway (MNWyf W K D W O D \ E H W Z H H Q 3 R U W D J H O D 3 U D L U L H D Q G < R U N W R Q / L N H R W K H r colonization railways they were subsidized with large land grants but were not successful at attracting many settlers. In fact, the poor performance of the colonization railways led Hedges (1934yf W R F R Q F O X G H P R U H L Q W H U H V W H G L Q V H F X U L Q g land than in operating railways, their every move was calculated to obtain the maximum amount of the best land, with a minimum expenditure of money and effort' (69yf , Q W K H & 3 5 E H J D Q R S H U D W L Q J W K H 4 / / D Q G Z K H Q L Q L W O H D V H G W K H 0 1 : L t secured a monopoly on rail transportation in Saskatchewan. Its position was maintained until 1905, when the Canadian Northern purchased the QLL. Then in 1907 1 Lewis applies his model to one area in Saskatchewan: Crop District 1 (1908-14 definitionyf D G L V W U L F t of about 16,800 square miles in the south-eastern corner of the province. 2 In his book on the history of the CPR, Innis (1971yf S R L Q W H G R X W W K H L Q W H U G H S H Q G H Q F H R I W K H G H F L V L R Q s made by the railway and the settlers both with regard to the timing of branch line construction and the setting of freight rates. See, in particular, the discussions on pages 129-30 and 172-9. This content downloaded from 142.104.160.247 on Wed, 01 Mar 2017 19:21:49 UTC All use subject to http://about.jstor.org/terms 342 / Frank D. Lewis and David R. Robinson _ ~~~YORKTON ?SAE s ' /5 l ~~35 M ILES TO 3 I NCH STRASSBURG / - - -QPATRICK FREGINA, N ARCOLA,- z~ U I - \\"\ ESTE VA -PORTAL LINES COMPLETED BEFORE 1898 - - - LINES COMPLETED FROM 1898 TO 1906 LINES COMPLETED FROM 1907 TO 1911 FIGURE 1 Rail lines: Crop District 1, Saskatchewan the CPR'S monopoly was further weakened as both the Canadian Northern and Grand Trunk Pacific completed main lines through the region. In fact, after 1907 the railway industry in Saskatchewan is best characterized as an oligopoly, and the monopoly model that we develop in the next section no longer applies. A MONOPOLY MODEL OF RAILWAY CONSTRUCTION A railway is assumed to secure a monopoly in a region of the frontier by constructing the only rail line through that region. Although completion of the main line may be premature based on current traffic and any subsidies that the railway receives, the railway anticipates that profits from future branch lines will be at least enough to offset current losses.3 Once the main line is completed, the firm's objective is to delay 3 Harley (1982, 797-805yf K D V D Q H [ F H O O H Q W G L V F X V V L R Q R I W K H H F R Q R P L F I D F W R U V D I I H F W L Q J W K H W L P L Q J R f main line and branch line construction. Indeed, one contribution of our paper is to formalize Harley's treatment. This content downloaded from 142.104.160.247 on Wed, 01 Mar 2017 19:21:49 UTC All use subject to http://about.jstor.org/terms The timing of railway construction / 343 the construction of branch lines until the net present value of each of these lines is maximized. Income from a branch line is assumed to come from two sources: net revenue from the rail traffic generated and rent on any railway land that is served by the line.4 Formally, the firm maximizes the net present value of each branlch line with respect to completion time and the freight rates that it charges once the line is opened: max rT {{[Pr(tyf & U W \f]F[t,Pr(tyf @ 3 5 > W 3 U W \f] jdt Pr(tyf T - [(r + 8yf O U @ S N H \f where Pr = rail freight rate, Cr = railway's operating cost, F = rail traffic generated by the branch line, p = proportion of land owned by the firm, R = effect of the line on land rents, Pk = cost of constructing the line, r = discount rate, 8 = depreciation rate of the line (this is assumed to be offset by maintenance and improvements to the lineyf , and T = optimal construction time (from the viewpoint of the firmyf 7 K H I L U V W R U G H r condition for the optimal construction time is [Pr(Tyf & U 7 \f]F[T, Pr(Tyf @ S 5 > 7 3 U 7 \f] = (r + 8yf 3 N \f The intuition for equation (2yf L V V W U D L J K W I R U Z D U G , W U H T X L U H V W K D W W K H U D L O Z D \ F R Q V W U X F t each branch line when the net revenue from rail traffic plus the increased rent on railway land equals the interest and depreciation on the road.5 The optimal freight rate in each period is the solution to the following equation, which is derived by differentiating equation (1yf Z L W K U H V S H F W W R 3 U W \f F[t, Pr(tyf @ S ^ G 5 > W 3 U W \fJ/dPr(tyf ` > 3 U W \f - Cr(tyf @ ^ G ) > W 3 U W \f]ldPr(tyf ` \f We derive both the rail traffic function, F, and the rent function, R, from the feasible region of wheat cultivation.7 In other words, we assume that the railway bases its freight rate and timing decisions on the assumption that settlers will occupy all land where wheat. farming is profitable. The margin of wheat cultivation establishes the boundary of this region. The boundary lies at that distance from a rail line where the exogenously given rnarket price of wheat equals the cost of producing the wheat and transporting it to market by wagon and rail: P(tyf F Z W \f + Pr(tyf 3 K W \f-D[t, Pr(tyf @ \f where p, = price of wheat, c, = cost of producing wheat (exclusive of land rentyf 3 h 4 Although railways seldom rented their land, land rents are assumed to be capitalized into the value of the land. 5 Since the annual cost of the line is constant, the second-order condition is that net income is rising at construction time. 6 In other words, the railway raises its freight rate until the increase in revenue due to the higher rate is just offset by a decline in income due to reduced rail traffic and land rent. 7 Our approach is based on the Lewis (1981yf P R G H O Z L W K W Z R V L P S O L I \ L Q J D V V X P S W L R Q V ) L U V W Z e assume that wheat yield is the same across all wheat land. Lewis assumed a normal distribution of yields. Second, we allow wheat to be shipped from any point along the rail line. Lewis required wheat to be shipped from loading platforms that were spaced about eight miles apart. Neither assumption seriously biases the results. This content downloaded from 142.104.160.247 on Wed, 01 Mar 2017 19:21:49 UTC All use subject to http://about.jstor.org/terms 344 / Frank D. Lewis and David R. Robinson = wagon haulage rate per mile, Pr = rail freight rate, and D is the distance from the line in miles where land rent is zero (all prices and costs are per bushelyf 5 H D U U D Q J L Q g equation (4yf J L Y H s D[t, pr(tyf @ > 3 Z W \f - Cw(tyf 3 U W \f]Ph(tyf \f If there is no overlap with other rail lines, each mile of track serves an area of 2D square miles. Wheat production in the feasible region provides the basis for computing the increase in rail traffic: F[t, pr(tyf @ ' > W 3 U W \f]Y(tyf I \f where y = wheat yield per acre, k is a factor that converts square miles into wheat acreage, and f is a factor that converts wheat production into rail traffic (in wheat equivalentsyf 7 K H L Q F U H D V H L Q O D Q G U H Q W L V D O V R E D V H G R Q W K H R X W S X W R I Z K H D W : R[t, Pr(tyf @ ' > W 3 U W \f]ky(tyf > > S 3 W \f - CW(tyf 3 U W \f]1M, (7yf where m is a factor that converts rent on wheat land to rent on all land. Note that since rent per bushel of wheat varies linearly from 0 (at the margin of cultivationyf W R S Z - Cw - Pr (at the rail lineyf D Y H U D J H U H Q W L V S Z & : 3 U \f. Finally, substituting equations (5yf \f, and (7yf L Q W R H T X D W L R Q \f, we derive the optimal freight rate to be Pr*(tyf > I O I S P \f] {[1 - p(f/myf @ > S Z W \f - cj(tyf @ F U W \f}. (8yf The derivation of the optimal freight rate can also be illustrated diagrammatically. In figure 2, A represents the demand curve for rail services and B the railway's average revenue curve, which lies above A if the railway owns land in the area served by the line. The firm maximizes profits by setting marginal cost equal to marginal revenue, based on the B curve. Note that if the firm owns all the land (and adjustment factors m and f are equalyf W K H V O R S H R I $ L V W Z L F H W K H V O R S H R I % D Q G W K H I L U P D F W V D V a perfect price discriminator, setting price equal to marginal cost. If on the other hand the firm owns no land, it charges the monopoly price, 2(pw - Cw - Cryf 8 AN APPLICATION OF THE MODEL TO CROP DISTRICT 1, SASKATCHEWAN We now apply the model to the construction of branch lines by the CPR in Crop District 1, Saskatchewan from 1898 to 1905. During the period the CPR laid three sections of track (see table 1yf $ P L O H E U D Q F K I U R P 5 H V W R Q W R $ U F R O D Z D V F R P S O H W H G L Q a 140-mile section of the Pheasant Hills branch, from Kirkella to Patrick, was 8 Engerman (1972yf G L V F X V V H G V R P H W K H R U H W L F D O L V V X H V F R Q F H U Q L Q J W K H V X E V L G L H V S U R Y L G H G W R X V U D L O - roads. He pointed out that giving a subsidy in the form of a land grant not only could lead to increased railroad construction but also would result in lower freight rates. In a recent PH D dissertation, Gillian Wogin (1983yf H [ S O R U H V W K H U H O D W L R Q V K L S E H W Z H H Q I U H L J K W U D W H V D Q G O D Q G V H W W O H P H Q W S R O L F \ L Q & D Q D G D . She finds that land grants to the CPR induced the railway to lower its freight rate from the monopoly price to a more efficient level. This content downloaded from 142.104.160.247 on Wed, 01 Mar 2017 19:21:49 UTC All use subject to http://about.jstor.org/terms The timing of railway construction / 345 Pr PW - S Pr* A \B Cr I \\MRB 0 F* F, F2 Rail traffic F, = [2(pw - CWyf N \ I 3 K - F2 = -4(pw cwyf N \ I @ > S K I S P \f]. F* = [2(pw- w- Cryf N \ I @ , > 3 K I S P \f]. FIGURE 2 Derivation of the optimal freight rate completed in 1904; and in 1905 the Reston-Arcola line was extended 113 miles to Regina (see figure 1yf : H D Q D O \ V H W K H W L P L Q J G H F L V L R Q V E \ F R P S D U L Q J W K H D Q Q X D O F R V t of each section of track with the income that each section was expected to generate during its first year of operation based on the actual freight rate (see equation (2yf W K e effect on the calculations of using optimal freight rates is discussed belowyf 7 K e capital cost of these lines was among the lowest of all track laid by the CPR on the Prairies - about $12,000 per mile.9 Multiplying by the sum of the discount rate and the depreciation rate of the road, put at 6 and 4 per cent, respectively, gives an annual cost of about $1,200 dollars per mile of track. 0 It is this amount that we compare with net income from rail traffic and land rents. To derive net revenue from rail traffic, we first compute the effect of each branch line on the feasible region of cultivation. Net revenue is simply the implied increase in the volume of traffic times the difference 9 The extension of the Pheasant Hills branch from Strassburg to Hardisty, for example, cost about $20,000 per mile, and the 270-mile Moose Jaw Branch, from Moose Jaw north-westerly to Macklin, cost $18,000 per mile. 10 Depreciation is assumed to have been offset by maintenance of track and structures. For all CPR lines the ratio of the cost of maintenance to the capital value of road and structures was about 4 per cent. The capital value is derived by cumulating all the (deflatedyf H [ S H Q G L W X U H V R I W K H & 3 5 R Q F R Q V W U X F W L R n and improvements (CPR, Annual Reportsyf . This content downloaded from 142.104.160.247 on Wed, 01 Mar 2017 19:21:49 UTC All use subject to http://about.jstor.org/terms 346 / Frank D. Lewis and David R. Robinson TABLE 1 The cost of constructing branch lines in Crop District 1, Saskatchewan Year Distance Cost per milea Line completed (milesyf \f 1. Reston to Arcola (Pipestone Extensionyf 0 2. Kirkella to Patrick (Pheasant Hills Branchyf 0 3. Arcola to Regina (Pipestone Extensionyf 0 4. Reston to Kaiserb (Wolseley Branchyf 0 SOURCES: CPR, Annual Reports, 1898 to 1908, appendices; Urquhart and Buckley (1965yf . aAll construction expenditures are deflated to 1890-99 dollars and compounded at 6 per cent to the year in which the line was completed. 'This line was completed after the CPR lost its monopoly in the district. It is included so that we can compare the monopoly with the oligopoly case. between the CPR'S freight rate and its operating cost. Finally, net income is obtained by adding to this amount the increase in land rent. We illustrate the calculation for the Reston-Arcola section, which was completed in 1901 (see tables 2 and 3yf , Q W K D W \ H D U W K H H [ W H Q V L Y H P D U J L Q R I F X O W L Y D W L R Q ' \f was 11.8 miles from the rail line and the feasible region per mile of track was 19.4 square miles.11 Average wheat output per square mile (kyyf Z D V E X V K H O V R I Z K L F K 8 per cent was marketed. 12 But wheat generated additional rail traffic in the form of other agricultural output, imported freight, and passengers. This traffic provided 90 per cent of the revenue obtained from carrying wheat. We assume, therefore, that the CPR transported the equivalent of 1.48 bushels of wheat for each bushel of wheat produced. 13 The revenue derived from this traffic is based on the CPR'S freight rate to Fort William, which in 1901 was the Crow rate of 10.1? per bushel. The CPR'S 11 From table 2, D = (Pw - C, - Pryf 3 K \f/0.567. The region served by the Reston-Arcola line was less than 2D square miles, because part of the track passed just south of the Moose Mountain Forest Reserve, an area unsuited for growing wheat. 12 Lewis (1981, 529-30yf H V W L P D W H G W K D W S H U F H Q W R I & U R S ' L V W U L F W Z D V V X L W D E O H I R U J U R Z L Q J Z K H D t and that mean wheat yield in 1901 was 14.94 bushels (case 3 of his modelyf 1 R W H W K D W W K H U H D U H 0 acres in a square mile.yf 7 K H S U R S R U W L R Q R I Z K H D W R X W S X W W U D Q V S R U W H G E \ U D L O L V E D V H G R Q D F R P S D U L V R n of the quantity of wheat inspected with the quantity produced over the period 1908 to 1911 (Saskat- chewan, Department of Agriculture, Annual Reportsyf . 13 A breakdown of rail traffic is available only by railway. To obtain an estimate of the traffic trans- ported on branch lines in south-eastern Saskatchewan we selected a small railway that served a comparable area. This was the Brandon, Saskatchewan and Hudson Bay Railway, a sixty-nine-mile line about sixty-five miles east of Crop District 1 that connected Brandon, Manitoba to Bannerman, near the U.S. border. Railway Statistics reports the tonnage of grain and other types of freight transported along this line. It is assumed that 84.2 per cent of grain tonnage consisted of wheat. This figure is based on output in Crop District 1 and a comparison of output and grain inspections for all of Saskatchewan - in converting bushels to tons the following weights are applied: wheat: 60 lbs; oats: 35 lbs; barley: 48 lbs; flax: 56 lbs. We estimate that the ratio of wheat and flour tonnage to the tonnage of all freight was 0.586. Finally, assuming that 10 per cent of railway revenue was generated by passenger traffic, we obtain a ratio of wheat traffic to all rail traffic of 0.527. Since 78.1 per cent of wheat output was marketed, it follows that the equivalent of 1.48 bushels of wheat was transported for every bushel of wheat produced. (These estimates are based on 1908- 11 averages; see Canada, Department of Railways and Canals, 1908-11; Saskatchewan, Department of Agriculture, 1908- 11.yf This content downloaded from 142.104.160.247 on Wed, 01 Mar 2017 19:21:49 UTC All use subject to http://about.jstor.org/terms The timing of railway construction / 347 TABLE 2 Data on the prices and costs of wheat production in Crop District 1, Saskatchewan (1890-99 cents per bushelyf 1898 1901 1904 1905 1908 Price of wheata 63.7 64.3 64.9 65.1 65.7 Cost of producing wheatb 48.8 47.5 49.5 49.7 46.6 Rail freight rate to Fort Williamc 10.1 8.6 9.0 7.9 Mean wheat yieldd(bushels per acreyf 9 Wagon haulage rate per milee 0.567 0.567 0.567 0.567 0.567 aThis is the (quality-adjustedyf W U H Q G S U L F H R I Z K H D W D W ) R U W : L O O L D P E H W Z H H Q D Q G O H V V " S H r bushel for commissions and handling (Lewis, 1981, 525-6yf . bLewis (1981yf V H S D U D W H G S R V W K D U Y H V W F R V W V Z K L F K Z H U H D V V X P H G W R G H S H Q G R Q \ L H O G I U R P W K H R W K H U F R V W s of producing wheat. Here we combine the two types of costs, but otherwise the cost estimates are the same (524-5yf . cFreight rates are given for each line in the year they were completed: 1901: Reston-Arcola; 1904: Kirkella-Patrick; 1905: Arcola-Regina; 1908: Reston-Kaiser. The freight rates are based on the average distance of each line from Fort William (McDougall, 1966yf . dBased on case 3 of Lewis (1981, 530yf eSee Lewis (1981, 526-7yf . operating cost of moving this wheat to Fort William was 7.0? per bushel, implying that net earnings per bushel were 3. 1 ?. Combining these values, it follows that on the Reston-Arcola section in 1901 net revenue from rail traffic was $1,500 per mile of track (0.031 x 1.48 x 1,690 x 19.4yf . Net revenue from rail traffic understates the full impact of the branch line on CPR income, because the firm owned a large share of the land in Crop District 1. In nearly every township the CPR had been granted the odd-numbered sections, less two sections that were designated as School Lands. Since there are thirty-six sections in a township, it follows that 44 per cent of the land in the district was owned by the CPR. In 1901 the Reston-Arcola line increased the rent on wheat land by $1,100 per mile of track. 14 This estimate, however, understates the impact of the line on all rents, because agricultural land also was used to raise livestock and to grow oats, barley, and other crops. Adjusting for these rents and for the fact that the CPR owned less than half the land, we estimate that per mile of track the Reston-Arcola line increased the rent on CPR land by $850.15 Combining land rent with net revenue from rail traffic and comparing the sum with the annual cost of the line, we conclude that, based on our model, the CPR should have completed the Reston-Arcola section prior to 1901. In 1901, the road imposed an annual cost of $1,240 per mile but provided income of $2,350: $1,500 from rail traffic and $850 as the increase in the rent on CPR land. The timing of the Kirkella-Patrick and Arcola-Regina sections conforms much 14 R = rent per bushel x wheat output per square mile x feasible region = -(p,-c-Pryf [ x 19.4 = 1,100. 15 The ratio of rent on all land to rent on wheat land, m, is estimated to be 1.76. This is the Crop District 1 average for 1908-1 1 and is based on the value of all field crops and the value of output generated by some livestock (milk cows, other cattle, sheepyf 6 D V N D W F K H Z D Q ' H S D U W P H Q W R I $ J U L F X O W X U H - 11.

This content downloaded from 142.104.160.247 on Wed, 01 Mar 2017 19:21:49 UTC All use subject to http://about.jstor.org/terms 348 / Frank D. Lewis and David R. Robinson TABLE 3 Annual costs and returns of Railway branch lines: Crop District 1, Saskatchewan (1890-99 pricesyf Reston- Kirkella- Arcola- Reston- Arcola Patrick Regina Kaiser (1901yf \f (1905yf \f 1. Annual costa (dollars per mileyf 0 2. Operating costb (cents per bushel - 7.0 7.2 7.4 6.9 cents per ton-mile in parenthesesyf \f (0.342yf \f (0.355yf 3. Freight rate (cents per bushel - 10.1 8.6 9.0 7.9 optimal rate in parenthesesyf \f (9.8yf \f 4. Area servedc (sq. miles per track mileyf 2 5. Income from rail trafficd (dollars per mileyf 0 6. Income from land rente (dollars per mileyf f 7. Annual income/annual cost 1.90 1.10 1.15 0.18 aO.I x capital cost (see table 2 and fn. 10yf . bOperating cost per ton-mile is based on the sum of the reported costs of conducting transportation, motive power (when givenyf D Q G W K H P D L Q W H Q D Q F H R I U R O O L Q J V W R F N $ O V R L Q F O X G H G D U H G H S U H F L D W L R Q D Q G L Q W H U H V W R n rolling stock, put at 5 per cent and 6 per cent respectively (a low depreciation rate was applied because of the high expenditures on maintenanceyf 7 K H Y D O X H R I U R O O L Q J V W R F N Z D V G H U L Y H G E \ F X P X O D W L Q J D O O & 3 R expenditures from 1885, and applying a 5 per cent depreciation rate. The share of operating costs attributed to freight is set equal to the share of income from freight. Operating cost per bushel of wheat is based on the distance to Fort William and a weight of 60 lb per bushel (CPR, Annual Reportsyf . cBased on equation (5yf D Q G W D E O H 7 K H U H V X O W V D U H D G M X V W H G G R Z Q Z D U G W R W D N H D F F R X Q W R I D U H D V W K D W D U H Q R t suited for wheat-growing and overlap with other rail lines. d[pr(tyf F : W \f] area served y(tyf N I Z K H U H N L V Z K H D W D F U H V S H U V T X D U H P L O H D Q G I W K H U D W L R R I U D L l traffic to wheat output, is 1.48 (see fn. 13yf . e2[p(tyf & W \f - Pr(tyf @ D U H D V H U Y H G \ W \f . kmp, where m, the ratio of rent on all land to rent on wheat land, is 1.76; and p, the share of land owned by the CPR, iS 0.44 (see fn. 15yf . fSince nearly all land served by the Reston-Kaiser section would have been in the feasible region without the line, the effect on land rent is small. more closely to the predictions of the model. These lines, completed in 1904 and 1905, respectively, generated less income per mile of track than the Reston-Arcola section because they overlapped with other lines and hence served smaller areas. In 1904, its first year of operation, the Kirkella-Patrick section imposed an annual cost of $1,200 but generated net revenue from rail traffic of only $580 (see table 3yf . Nevertheless, the line was completed at about the optimal time because the shortfall was more than offset by an increase in the rent on CPR land. The timing of the Arcola- Regina section was also close to optimal. In 1905, when that line was completed, the annual cost was $1,240 and net income, including land rent, was $1,430. An important implication of these results is that the land grants to the CPR accelerated branch line construction, even though they were mainly intended to subsidize the transcontinental line. Had the CPR owned no land, completion of both the Kirkella-Patrick and Arcola-Regina sections would have been delayed. In fact, when these lines were first opened, the CPR derived more income as capitalized land rent than as net revenue from freight and passengers. This content downloaded from 142.104.160.247 on Wed, 01 Mar 2017 19:21:49 UTC All use subject to http://about.jstor.org/terms The timing of railway construction / 349 TABLE 4 Hypothetical costs and returns of railway branch lines (1890-99 pricesyf ' Reston-Arcola Kirkella-Patrick Arcola-Regina A B A B A B 1. Operating costb 7.7 7.7 8.5 8.5 8.7 8.7 2. Freight rate 13.1 10.3 13.1 10.6 13.7 10.7 3. Area served 6.3 14.1 5.9 12.4 4.0 12.8 4. Income from rail traffic 850 920 680 650 500 640 5. Income from land rent 75 425 70 350 30 350 6. Annual income / annual cost 0.75 1.08 0.62 0.83 0.43 0.80 A = based on 1898 values. B = based on 1898 values but assuming the optimal freight rate in that year. aFor the units in which variables are expressed, see table 3. bIn 1898 operating costs were 0.403? per ton-mile (see table 3, fn. byf On the basis of our model, we accurately predict the timing of two of the three rail lines in our study but estimate that construction of the third, the Reston-Arcola section, was delayed. The Reston-Arcola section was completed in 1901, when net income provided by the line far exceeded its annual cost. Surprisingly, however the lag between the optimal and actual completion time was at most two years. We establish this by recomputing our results using data for 1898 (see table 4yf , Q W K D W \ H D r the Reston-Arcola section would have generated net income, including capitalized land rent, of $925, which is only three-quarters of the annual cost of the road. It was optimal, therefore, for the CPR to wait until at least 1899 before completing the line. In addition to explaining construction time, our model can also help account for the freight rates charged by the CPR. Between 1898 and 1905 the CPR reduced its nominal freight rates twice. In 1899 the freight rate to Fort William was reduced by 3? per cwt'6 in accordance with the Crow's Nest Pass Agreement. Then in 1903 the Manitoba Agreement lowered nominal freight rates a further 2? per cwt. We have compared actual and optimal freight rates on the three lines for the years when each line was completed. In 1901, for example, the optimal freight rate to Fort William from the Reston-Arcola section was 10.2? per bushel (see table 3yf Z K L F K L V D O P R V t identical to the actual rate - the Crow - of 10. 1?. On wheat shipped from the Kirkella-Patrick and Arcola-Regina sections, optimal freight rates were 9.8? and 10.0? per bushel, respectively, in the years when those lines were completed. These rates are well below the Crow rates of 11.6? and 11.9? but are close to the rates stipulated in the Manitoba Agreement, which by then was in effect. It should be noted than land ownership by the CPR reduced the optimal freight rate by about 1.5? per bushel. Our results indicate that, as a monopolist, the CPR followed a close to optimal plan with respect to both freight rates and the timing of branch line construction. Next, we 16 Freight traffic in Canada was measured on the basis of American units: 100 lbs per cwt and 2,000 lbs per ton. This content downloaded from 142.104.160.247 on Wed, 01 Mar 2017 19:21:49 UTC All use subject to http://about.jstor.org/terms 350 / Frank D. Lewis and David R. Robinson combine our findings with those of Lewis (1981yf W R K H O S F R P S O H W H R X U H [ S O D Q D W L R n for the timing of the wheat boom. In his paper Lewis showed that in south-eastern Saskatchewan large-scale prairie settlement had to await the completion of railway branch lines. In this paper we show that the reason branch line construction did not take place earlier was that prior to 1899 branch lines would have generated less income per year than the annual cost of the lines. After 1899 conditions changed and the laying of track became the profit-maximizing course to follow. Two factors contributed to the increased profitability of prospective branch lines: the Crow's Nest Pass and Manitoba agreements and a decline in the operating costs of the CPR. We have shown that the Crow and Manitoba agreement rates were close to optimal; however, prior to 1899, when the Crow agreement came into effect, the CPR charged much higher freight rates. An immediate question arises: why did the CPR wait for the implementation of the Crow's Nest Pass Agreement to lower its rates? We offer the following answer, first suggested by Gillian Wogin (1983yf : K H Q V H W W O H U s purchased land from the CPR, the price that they paid was determined not by current wheat prices and costs of production, but rather by expected future prices and costs. Without the Crow's Nest Pass Agreement or one like it, settlers expected that once they purchased the land, the railway would raise its freight rate in order to extract more monopoly rent. This meant that the lowering of current freight rates would have had little effect on the capitalized value of CPR land, which led to suboptimal pricing. It was only after the CPR was in a position of precommitment that reductions in freight rates would significantly affect land prices and thereby increase the income from branch line construction. The Crow's Nest Pass Agreement may have been a necessary condition for branch line construction, but it was not a sufficient one. Even if the CPR had charged the profit-maximizing freight rate in 1898, it would not have been optimal to construct either the Kirkella-Patrick or the Arcola-Regina line (see table 4yf , Q I D F W H Y H Q W K e Reston-Arcola section would have generated just slightly more income than its annual cost. The problem was the CPR'S high operating cost. Recently Alan Green (1983yf K D s compiled evidence showing rapid technological change in the railway sector during the 1890s and early 1900s. Data on the CPR'S operating costs are consistent with his results. From the 1890s to the period 1900- 10 operating costs fell from 0.4? to about 0.35? per ton-mile. 17 This reduction may seem small, but it had a big impact on the margin between freight rates and operating costs. 8 Green has not identified the sources of railway productivity change in Canada, but Fishlow (1966, 626-31yf Z K o also estimated large increases in total factor productivity for u.s. railroads during this period, points to the increased size of locomotives, their increased motive power per unit weight, and the higher ratio of load to dead weight in freight cars. These changes may have affected Canadian railways as well. On the Canadian Prairies, moreover, improvements in productivity not only led to reductions in freight rates; they also contributed to the extension of the rail network. 17 Operating costs are derived from the CPR, Annual Reports. See table 3, fn. b. 18 In 1905, for example, the freight rate on the Kirkella-Patrick branch exceeded operating costs by 1.4? per bushel. But had operating costs been at their 1898 levels, this margin would have been reduced to 0. 1? (given the 1905 freight rateyf . This content downloaded from 142.104.160.247 on Wed, 01 Mar 2017 19:21:49 UTC All use subject to http://about.jstor.org/terms The timing of railway construction / 351 Our monopoly model, which accounts well for railway construction between 1898 and 1905, is no longer appropriate by 1907. In that year the industry became an oligopoly, as the CPR, Canadian Northern, and Grand Trunk Pacific all competed for traffic. The oligopoly case has been analysed by Harley (1982yf I R U E U D Q F K O L Q e construction in the u.s. mid-west. Harley argues that once a railway loses its monopoly, or if an oligopoly agreement breaks down, a construction boom will occur. Fearing pre-emptive railway construction by competitors, firms now build lines whose net present value is positive, whereas in the monopoly case they wait until the net present value of each line is maximized. The story Harley tells for the u.s. mid-west also fits Crop District 1, Saskatchewan. After 1907 there was a construction boom in which all three railways participated; moreover, the branch lines completed during this boom were certainly built before their present values were maximized. In 1908, for example, the CPR line from Reston to Kaiser (see figure 1yf L P S R V H G D n annual cost of $1,220 and generated income of only $215 (see table 3yf 6 X U S U L V L Q J O \ , however, the collapse of the CPR monopoly in Crop District 1 had little effect on settlement, because enough branch lines had been completed prior to 1907 to bring nearly all land into the feasible region of wheat cultivation (Lewis, 1981, 523yf 7 U D F k laid after 1907 was for the most part redundant, in that it had almost no effect on settlement. CONCLUSION As Lewis (1981yf V K R Z H G Z L W K D P R G H O E D V H G R Q W K H I H D V L E O H U H J L R Q R I Z K H D W F X O W L Y D - tion, settlement advanced not with the CPR'S transcontinental line but rather with the construction of railway branch lines. It is, therefore, the timing of branch line construction that is the focus of our paper. We first develop a monopoly model of railway construction that makes use of the Lewis approach. We than analyse three CPR lines built in south-eastern Saskatchewan between 1901 and 1905. We find that the CPR completed each section of track at about the time that maximized its net present value. In fact, as late as 1898 it would not have been profit-maximizing to lay any of the three sections. The Crow's Nest Pass Agreement, which came into effect in 1899, was important in raising the profitability of prospective branch lines. Since the agreement set long-term ceilings on freight rates, it increased the capitalized value of CPR land by promising settlers low future, as well as low current, freight rates. Productivity change in the railway sector was even more important. It lowered operating costs, reduced (optimalyf I U H L J K W U D W H V D Q G H [ W H Q G H G W K H I H D V L E O H U H J L R Q R f cultivation per mile of track. This led to increased rail traffic and land rent, which made the construction of new rail lines profitable. We now return to the first issue raised in this paper: the long period between the completion of the CPR'S transcontinental line and the start of large-scale settlement. We think that the reason many economic historians have been puzzled by the long delay is that they have been posing the wrong question. Rather than ask 'why did settlement begin so late?' they should have been asking 'why was the transcontinental line completed so early?' On the basis of our model we can provide a partial answer. With the completion of the transcontinental, the CPR established a monopoly on the This content downloaded from 142.104.160.247 on Wed, 01 Mar 2017 19:21:49 UTC All use subject to http://about.jstor.org/terms 352 / Frank D. Lewis and David R. Robinson provision of rail services throughout much of the Prairies. The value of this monopoly was the expected net present value of the future branch lines that it built. The cost of establishing the property right to these future returns was the present value of expected losses due to premature construction. Of course huge government subsidies substantially reduced net construction costs and contributed to even earlier completion of the line. With the exception of the land grants, however, it is unlikely that these subsidies had much impact on the timing of settlement. REFERENCE S Canada, Department of Railways and Canals (1909-12yf 5 D L O Z D \ 6 W D W L V W L F V W R , n Parliament of the Dominion of Canada, Sessional Papers (Ottawayf Canadian Pacific Railway Company (CPRyf $ Q Q X D O 5 H S R U W V W R 0 R Q W U H D O \f Dick, Trevor (1982yf 0 H F K D Q L ] D W L R Q D Q G 1 R U W K $ P H U L F D Q S U D L U L H I D U P F R V W V ' Journal of Economic History 42, 199-206 Engerman, Stanley L. (1972yf 6 R P H H F R Q R P L F L V V X H V U H O D W L Q J W R U D L O U R D G V X E V L G L H V D Q G W K e evaluation of land grants.' 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(1971yf $ + L V W R U \ R I W K H & D Q D G L D Q 3 D F L I L F 5 D L O Z D \ 7 R U R Q W R 8 Q L Y H U V L W \ R f Toronto Pressyf Lewis, Frank D. (1981yf ) D U P 6 H W W O H P H Q W R Q W K H & D Q D G L D Q 3 U D L U L H V W R - R X U Q D l of Economic History 41, 517-25 Marr, W. and M. Percy (1978yf 7 K H J R Y H U Q P H Q W D Q G W K H U D W H R I S U D L U L H V H W W O H P H Q W 7 K L s JOURNAL 11, 757-67 McDougall, John Lome (1966yf 7 K H U H O D W L Y H O H Y H O R I & U R Z V 1 H V W J U D L Q U D W H V L Q D Q d 1965.' Canadian Journal of Economics and Political Science 32, 46-54 Norrie, Kenneth H. (1980yf & X O W L Y D W L R Q W H F K Q L T X H V D V D U H V S R Q V H W R U L V N L Q H D U O \ & D Q D G L D n prairie agriculture.' Explorations in Economic History 17, 386-99 Saskatchewan, Department of Agriculture (1907-12yf $ Q Q X D O 5 H S R U W V W R 5 H J L Q D \f Urquhart, M.C. and K.A.H. Buckley, eds (1965yf + L V W R U L F D O 6 W D W L V W L F V R I & D Q D G D 7 R U R Q W R \f Wogin, Gillian (1983yf 7 K H Z H D O W K P D [ L P L ] L Q J E H K D Y L R X U R I W K H & D Q D G L D Q S D F L I L F U D L O Z D \ : lands, freight rates, and the Crow's Nest Pass Agreement.' PH D dissertation, Carleton University This content downloaded from 142.104.160.247 on Wed, 01 Mar 2017 19:21:49 UTC All use subject to http://about.jstor.org/terms