Part 29

Bearing in mind that the foregoing was addressed to the particular proposal made by Professor Adams, that being the topic on which the writer was invited to speak, a proposal expressly limited to the ascertainment of cost of reproduction less depreciation (the equivalent of cost of replacement with second-hand materials in a condition equivalent to that of the materials in use and hereinafter referred to as "cost of replacement") under the pseudonym of "physical value" (or sometimes "inventory value"), it would seem as though Mr. Riggs should sympathize with the writer's view, rather than with that of Professor Adams. Certainly, Mr. Riggs is fully aware of the inadequacy of mere cost of replacement to serve any useful purpose, for, after saying that:

"No account may be taken of the purpose for which the resultant figure of value is to be used; and the result should not vary, no matter what the purpose may be."

He says, in another place:

"* * * it is clear that the worth of the physical property, being the cost of reproduction less depreciation, is not necessarily the value of the property. * * *"

And, defining what he calls the "non-physical or intangible elements of value," says:

"These are those things which, added to or taken from the worth of the physical property, make up the value, and include whatever accrues to the property by reason of its operation, or by reason of grants, contract rights, competition, or location, which at the time of appraisal affect favorably or unfavorably the worth of the property."

The second misapprehension that is worthy of notice seems to have grown out of a curious sensitiveness, on the part of Mr. Riggs, as to any suggestion, other than his own, of criticism of any work undertaken or theories advanced by Professor Adams. As to every reader, other than Mr. Riggs, it is surely quite unnecessary to say that no attack has been made upon Professor Adams by the writer at the New York meeting of the American Economic Association or anywhere else. Certainly, it will be conceded that some difficulty would attend an effort to respond to an invitation to discuss before a scientific body a paper written by one of its members without making any allusion to the author of the paper or to his views or work, and those who have any knowledge of the history of official railway valuations in the United States, and especially of the proposal to undertake a Federal investigation of cost of replacement, are fully aware that Professor Adams has been from the beginning, and now is, the Hamlet of the drama, without whom it would become dull and lifeless. Strangely enough, Mr. Riggs seems to wish to deny to Professor Adams this prominence, for he says:

"Professor Adams was associated with the Michigan appraisal, but had no connection whatever with the 'physical valuation,' to which such objection is taken, and his appointment was made after the work of physical valuation had been fully outlined and was well under way."

It is true that the scheme devised by Professor Adams, and adopted at his suggestion by Governor Pingree, required the employment of civil engineers for the preliminary work which necessarily had to precede the final "valuation" by Professor Adams, but the bare statement of this fact is utterly misleading. Professor Adams' own testimony in one of the Michigan tax cases happily places his responsibility for the whole plan entirely beyond controversy. He said:

"In 1900 I was called upon by the Michigan State Tax Commission to determine whether railroads were paying a tax rate on their value equal to the rate on other property. With that problem in view, I formulated this inventory plan. * * *"[33]

Any discussion of the proposal for a National inquiry concerning cost of replacement which omits to show that its most persistent advocate, Professor Adams, has advocated and actually conducted or controlled several successive "valuations," in Michigan, as Statistician to the Interstate Commerce Commission, and as special employee of the Bureau of the Census, made in accordance with other methods than those which he now proposes to apply, is seriously inadequate; as seriously inadequate as it would be to omit to state that, using what purported to be the same method, Professor Adams, by changing the details of its application and decreasing the rates of interest used in his computations, raised his "valuation" of Michigan railways from $152,958,202 to $177,689,292 or 16.17%, each of the two calculations being presented to the public, with assurances that it disclosed the actual taxable value, and there being barely eighteen months between them. The writer is by no means alone as an object of Mr. Riggs' dissatisfaction because of public criticisms of Professor Adams' plan for estimating cost of replacement. Thus, of a statement in which Professor Taylor, who conducted the Wisconsin inquiry, questioned the validity of some of Professor Adams' methods, he writes:

"Undoubtedly this statement was made in good faith, and has gained currency by not having been corrected, but it is not the fact."

In another place, referring to a statement of comparative costs to the respective States for valuation work, made by the Railroad Commission of the State of Washington, he says:

"It does not appear to be good taste either to criticize costs of work in other States, or compare the costs in Wisconsin and Michigan with the cost in Washington."

Referring to a paper by Charles Hansel, M. Am. Soc. C. E., who took part in the Michigan valuation, Mr. Riggs says:

"The one point to which special attention is drawn is Mr. Hansel's astonishing misconception of Professor Adams' plan of work. This misleading statement appears in the first paper and is reiterated in the second."

Again, of the report of the expert of the Washington Railroad Commission, who had the temerity to declare that it found "little value" either in Professor Adams' methods or his estimates of the cost of the work, Mr. Riggs says:

"Such sentences, and others which, by inference if not by name, reflect on work executed by men of high professional standing, are hardly in good taste, even if true, in a report to a railroad commission of another State."

Yet Mr. Riggs does not fail to criticize the method of "valuation," applied by Professor Adams in Michigan, in terms quite as definite as any used by others.

Thus, he condemns the method used to estimate the value of the non-physical elements appertaining to the Michigan railways, on the grounds (first) that it made this value a mere derivative of the rates existing, and (second) that it made no allowance for negative values when cost of replacement exceeded real value, saying:

"It will be seen that, in the case of a property in which the surplus earnings depend on excessive rates for service, it will fail as a method of determining a value for use as a basis of rate-making; and it fails, in the form in which it was used in 1900 and 1902, to bring out those negative or subtractive elements which may be determined from the income accounts, in the case of properties which do not earn a fair return on the investment."

Of the published statistics of American railways, compiled in the office of which Professor Adams is the responsible head, derived from annual reports made in accordance with forms prescribed by the Interstate Commerce Commission under his guidance, and containing items selected from and depending on the uniform railway accounting system devised by Professor Adams and imposed on the carriers by the Commission, Mr. Riggs writes:

"The published statistics are in such form that only the careful student of affairs can understand or analyze them, and but few of the public officials who receive them are able to read the reports of the properties and comprehend them."

Railway officers fall quite generally under Mr. Riggs' condemnation, for, of them he says:

"As a body * * * it is doubtful if any equal number of men, of equal intelligence, have as limited a knowledge of the fundamental truths of government, or knowledge so colored by bias. It is also doubtful whether any equal number of men have in their ranks so few who bear an active part in the duties and activities of citizenship, or who exercise large influence on their neighbors."

Such assertions as the foregoing need no comment; their intemperance is their most effective refutation; yet a few recent examples may be cited: Paul Morton resigned as Vice-President of the Atchison, Topeka and Santa Fe to become Secretary of the Navy in Mr. Roosevelt's cabinet; Jacob M. Dickinson, General Solicitor of the Illinois Central, became Mr. Taft's Secretary of War; his successor with the Illinois Central, William S. Kenyon, later became Special Assistant of the Attorney-General; Lloyd W. Bowers, General Solicitor of the Chicago and Northwestern, was Solicitor-General of the United States from early in Mr. Taft's administration until his death a few months ago. Thus, within but four or five years, the Federal Government took four of its highest officers from the railway officers located in only one of the country's great cities—Chicago.

Of a recent address by one of the ablest and most public-spirited of railway officers, he says:

"This address well expresses the spirit of the railway managers and employees toward all forms of investigation, and the complete lack of understanding, on the part of these managers, of the legal and moral relations which they bear to the communities which they serve."

Belonging to this so hateful class, and having also ventured to question whether Professor Adams has said the last and most perfect word on the subject of railway valuation, the writer is neither surprised nor disheartened to find that he, also, has caused Mr. Riggs undisguised dissatisfaction. It is a misfortune apparently inseparable from his profession and his conception of his obligations to his employers and to the public.

As has been already noted herein, the question is not whether railway property shall be officially "valued," but rather (first) as to how the "value" which is to be ascertained is properly to be defined, and (second) how the determination of "value," as properly defined, can be made most accurate.

The essential difference between the view advocated before the American Economic Association by Professor Adams and that of the writer was, and is, that the former now desires to exclude all elements of value which are not physical and tangible, while the writer holds that, if it is worth while to ascertain, on a general scale, at the cost of a necessarily large expenditure of taxpayers' money, and as to a particular date, so unstable a fact as railway value, the kind of value the ascertainment of which could be of sufficient utility to warrant the effort can be nothing less significant than the "fair value" which the Courts have said is a proper element for consideration in fixing reasonable rates of charge. The fundamental difference between these two conceptions of value is admirably indicated by the following quotations, both of which rest on the authority of the Interstate Commerce Commission.

FAIR VALUE.

"The present value of a railroad property is necessarily very largely a matter of opinion only; it depends upon a vast number of contingencies and uncertainties, a road apparently of great value to-day may soon become worthless by the opening of a competing line having superior advantages or by the competitive struggles of other lines which operate to reduce the income of all; the value of a railroad largely results from the personal characteristics of its officials; the policy pursued by directors for the conservative and economical or progressive and daring, is a great factor in the determination of the current value of the property; a railroad property is not necessarily worth what it would cost to replace it and, on the other hand, it may be worth very much more than that."[34]

REPLACEMENT COST.

"The bill in question makes use of the phrase 'fair value.' Unless there is some legislative necessity, which we do not perceive, we question the advisability of using this phrase.

"It would seem to us preferable to substitute a phrase which indicates the fact that Congress desires an inventory valuation of railway property. By inventory valuation is meant that the property of the several railways shall be listed in detail, and that each kind or class of property so listed shall have assigned to it a valuation to be determined from the point of view of the contracting engineer, and not from the point of view of a court or board of arbitration which, from the nature of the case, cannot judge of what is 'fair value' except in the light of some specific use to be made of the valuation."[35]

As has already been noted herein, and amply verified by quotations, Mr. Riggs is fully aware that replacement cost and real value can rarely, if ever, coincide, and therefore plainly agrees, as to that elementary and essential point, with the writer and disagrees with Professor Adams, who would ignore or destroy every non-physical element of value in the property of all public service corporations. Mr. Riggs' recognition of the inadequacy of mere replacement cost is shown also by the excellent and convincing example which he cites[36] of competitive railway routes between two Michigan cities which were built and are maintained and operated under such conditions that the far more costly of the two, which inferentially has correspondingly higher replacement cost, has much lower earning capacity, both as to gross and net, and is therefore actually worth much less than its less costly competitor. Mr. Riggs explicitly favors full recognition of the non-physical elements in every valuation; and, therefore, may be ranked as an opponent of any such scheme of valuation as that advocated by Professor Adams before the American Economic Association, or in the letter of the Chairman of the Interstate Commerce Commission, hereinbefore quoted.

Mr. Riggs, however, believes that the determination of the cost of replacement is an essential first step toward the ascertainment of real value. He says:

"The worth of the physical property is primarily that on which the value of the whole property rests."

The thought which the writer would place in opposition to the foregoing is that: Physical property has no value which is not an expression of its adaptation to economic needs. This is only another way of expressing the inevitable economic law, from which there is no escape, either in theory or in practice, that has been stated and sanctioned by the Supreme Court of the United States, as follows:

"But the value of property results from the use to which it is put, and varies with the profitableness of that use, present and prospective, actual and anticipated. There is no pecuniary value outside of that which results from such use."[37]

Mr. Riggs' own definition of value is not inconsistent with the foregoing. He says:

"The value of a property is its estimated worth at a given time, measured in money, taking into account all the elements which add to its usefulness or desirability as a business or profit-earning proposition."

The view of Mr. Riggs is that:

"While ... the worth of the physical property, being the cost of reproduction less depreciation, is not necessarily the value of the property, ... the physical worth must bear some very definite relation to value...."

And he is, further:

"Strongly of the conviction that this relation is such that 'value' cannot be ascertained without a determination of physical worth."

It is exceedingly difficult to comprehend just what Mr. Riggs means when he describes the relation between real value (which he recognizes so clearly as value in use) and cost of replacement as "very definite." Certainly, he does not mean that it is a constant relation, or one which can be ascertained until there has been independent determination of both of the aggregates whose relation it expresses. In fact, the emphasis which Mr. Riggs places on replacement cost has led him into the grotesque fallacy of arguing that a correct estimate of real value is only to be attained by ascertaining: (first) cost of replacement, (second) real value, and (third) correcting the aggregate first obtained by applying whatever "very definite" relation (ratio) is necessary to make it agree with the second aggregate, which was from the beginning the only aggregate really wanted. The accuracy of this characterization of his proposed procedure is made perfectly clear by the following quotation:

"... the true method of valuing a corporate property is first to determine the cost of reproduction of the property and its depreciation, and modify this figure by any applicable positive or negative non-physical elements of value."

It is submitted that the clear meaning of the foregoing is that both replacement cost and real value as derived from use must be separately and independently ascertained, and that, these aggregates having been compared, the former is to be corrected by whatever allowance for non-physical value may be required to make it agree precisely with the latter. The obvious suggestion flowing from this discovery of his theory is that only value in use is wanted, as that is the only real value, and as it must be separately ascertained in any event, no other and _pseudo_ value need be taken. The essential character of the method is as described, even when it is applied through determination of the annual value of the use and the assignment of one portion of such annual value to return on the capital value of the physical property and another portion to return on the capital value of non-physical property. The real nature of the method is not even effectually concealed by the capitalization of the income assigned to physical property at one rate and the income assigned to non-physical property at a different and higher rate. In fact, if it is necessary to conclude that a portion of the net annual income of railway property is normally paid to, or in respect of, a portion of capital entitled to a lower rate of return, and the remainder to or in respect of a remainder of capital entitled to a higher rate, the appraisal of the physical property is an excessively costly, cumbersome, and inaccurate expedient for determining the amount or value of either portion of the capital. Yet that is exactly what was done in Michigan by Professor Adams, the "valuation" he then made being completed before he altered his view by deciding that the non-physical elements of value are entitled to no consideration whatever, and that only cost of replacement is worthy of inclusion in an official "valuation."

But is there any real distinction between the "physical properties" and the "immaterial elements," such as the foregoing extract seems to assume? Is not the superficial appearance of such a distinction plausible but deceptive? A locomotive is an entity; so is a railway. The separate parts of a locomotive are most of them independently valuable; so are the separate parts of a railway; but a large share of the value of the locomotive is the result of the nice adjustment of these separate parts to each other and to the work to be done.

Take a hundred different-sized locomotives, each adapted to different work under different conditions, and separate each piece of metal; it would be possible to value all these parts, but the aggregate would be far less than the value of the locomotives from which they were taken. Again, it would be possible to construct from these parts a hundred locomotives of such poor design, their respective parts so out of adjustment and balance, that they would be worth even less than the parts out of which they were assembled. The highest paid intelligence has not yet contrived the perfectly balanced locomotive, but a large part of the so-called "physical value" of every locomotive represents this sort of highly paid intelligence put forth at every stage from the opening of the mine where the ore was obtained to the delivery of the completed locomotive. Take ten railways of a thousand miles each, every one of them efficiently constructed, and equipped with proper terminals, stations, signals, rolling stock, and trained employees, and each properly adapted to the requirements of its territory and traffic; separate them into piles of ties and rails, groups of locomotives and cars, acres of land, unorganized bodies of men of varied capacity and training; what sort of intelligence will it require to build up out of these masses ten railways as efficient and useful as those that originally existed? Why, then, should the "physical value" of the locomotive include the assembling of its parts in proper balance and the "physical value" of the railway exclude the cost of the much more complicated adjustment of its elements of machinery and labor and location to each other?

At an early point in his discussion, Mr. Riggs makes an announcement, highly becoming on the part of one who proposes to deal with the problem solely from the point of view of a civil engineer, that he does not intend to argue the public utility of any sort of valuation, but only the method by which it may best be made, should one be determined upon. He says:

"This paper is confined to a discussion of the methods which should be used in arriving at a correct figure of cost of reproduction and depreciation—it does not take up questions involving the propriety of those figures when reached. The propriety or legality of using such figures as a basis for an assessed valuation, as a basis for rate-making (rate-making being an art in itself involving complications as great as those encountered in valuation), or any arguments as to the justice or injustice of legislation restricting issues of stocks or bonds, will be conceded no place in this paper. It is assumed that all these questions would have been taken up and a satisfactory answer reached before a valuation could have been ordered."

Two pages after the foregoing paragraph, under the sub-heading "The Relation of Public Service, or Quasi-Public Corporations, to the People," Mr. Riggs proceeds to violate the wise, though self-imposed restriction, and devotes no less than eleven pages to a defense of the project on grounds of alleged public policy. In these pages he concludes that such a valuation as he proposes—not a mere determination of replacement costs, but a real valuation, with proper allowance for all elements of value in use—would be of service in connection with (_a_) taxation, (_b_) public control of rates, and (_c_) public control of issues of capital securities.