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 THE HITCHCOCK LECTURES 
 
 OF THE 
 
 UNIVERSITY OF CALIFORNIA 
 1918 
 
 GEORGE PILLMORE SWAIN 
 
 [Reprint from "The Semicentenary Celebration of the Founding of the 
 University of California . . . 1868-1918."] 
 
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THE HITCHCOCK LECTUEES OF THE UNIVEESITY OF 
 CALIFORNIA, 1918 
 
 GEORGE FILLMORE SWAIN, B.S., LL.D. 
 
 Gordon McKay Professor of Civil Engineering in the Massachusetts 
 Institute of Technology, Harvard University 
 
 [First Lecture] 
 THE FIRST QUEBEC BRIDGE AND ITS FAILURE 
 
 This lecture dealt with the subject of the first bridge erected 
 across the St. Lawrence River just above Quebec, which failed 
 August 29, 1907. It was illustrated by many lantern slides, 
 which traced the history of the structure, explained the type 
 adopted and its relations with other types of long span bridges, 
 discussed the methods of erection of bridges, showed the details 
 of the structure, and finally described its failure and the reasons 
 for this. 
 
 This bridge as planned was to have a single span of 1800 feet, 
 the longest span in the world. The main structure was a canti- 
 lever bridge, of three spans, located about seven miles above the 
 City of Quebec. The largest span is ninety feet longer than the 
 two spans of the Forth Bridge, which was completed in 1889. 
 
 The piers of the Quebec Bridge had been completed and the 
 superstructure of the southerly half was being erected by first 
 erecting the southerly shore arm on scaffolding, and then building 
 out the long span piece by piece by means of travellers. The 
 southerly cantilever arm had been completed and the suspended 
 span in the center of the structure, which is supported at each 
 end upon two cantilever arms, was being built from the south- 
 erly end. The heavy traveller at the end of the projecting arm, 
 which had been used in building the southerly cantilever arm y 
 had been removed, and the central supported span was being 
 built with a lighter traveller. A few days before the accident 
 one of the inspectors discovered that one of the lower chord 
 members of the southerly anchor arm near the river pier had 
 buckled or bent out of line about two inches. A deflection at 
 this place had been noticed the previous week, but at that time 
 it was only three-quarters of an inch. 
 
While some of the employees appear to have felt uneasy with 
 regard to this buckling, it was apparently considered by those in 
 charge to be insignificant and not a cause for anxiety. On 
 August 28th a conference of the chief engineers and others in 
 authority was held, and it was decided to place the situation 
 before the consulting engineer in New York. A messenger went 
 to New" York for this purpose, and the consulting engineer, after 
 "conference, telegraphed Phoenixville, where the bridge was being 
 fabricated, and sent his representative there for consultation 
 with the officers of the bridge company. By the time he arrived 
 at Phoenixville the bridge had collapsed. Eighty-five men went 
 down with the bridge, and of these only eleven were saved. 
 
 No such mass of steel work had ever collapsed in the history 
 of bridge building. Some 17,000 tons of steel formed one tangled 
 mass of debris, extending from the anchor pier over the central 
 pier down into the main current of the river. 
 
 A study of engineering failures is more enlightening than a 
 study of engineering successes. The lecture discussed the causes 
 of the disaster, and drew the lessons which it taught. 
 
 The material and workmanship of the bridge was considered 
 to have been excellent. The disaster was not attributed to any 
 flaw in material or defect in manufacture. It was due to the 
 failure of the compression member and the buckling which had 
 been noticed. This compression member had been designed 
 without taking due account of the actual weight of the structure, 
 the stresses in it were allowed to be too high, and the design was 
 extremely faulty. The lattice bars connecting the parts of the 
 member were much smaller in strength, in proportion to the size 
 of the piece, than those used in ordinary design. These lattice 
 bars had hitherto been designed in a purely empirical manner, 
 although it is possible to apply to them some principles of mechan- 
 ics. The lecturer, after the failure of the bridge and after obtain- 
 ing details of the structure, had computed the strength of these 
 columns and had found that failure should have taken place 
 almost precisely when it did. 
 
 Facts and figures were given with reference to the details and 
 the causes of the failure, which it is not necessary to discuss 
 further in this abstract. 
 
[Second Lecture] 
 THE SECOND QUEBEC BRIDGE 
 
 A strange fatality seems to have pursued this structure. 
 After the failure of the first bridge, plans were made for a new 
 one at the same place and with the same span, although the 
 width between trusses was greater. The design of the new struc- 
 ture was radically different from that of the old one, and the 
 differences between the two were explained and illustrated by 
 lantern slides. 
 
 The new bridge, like the old, was a cantilever bridge of three 
 spans. The central supported span, which rests on the end of 
 the cantilever arms, which in the old bridge was being built piece 
 by piece from the cantilever arm, was in the new bridge designed 
 to be built complete on the shore of the river. When completely 
 erected, scows were to be run beneath it and the load transferred 
 to these scows, which were then to be towed up the river until 
 this supported span was in position between the two ends of the 
 cantilever arms, which had previously been completely erected, 
 and the supported span was then to be raised by hydraulic 
 machinery into its permanent position. 
 
 Great care had been taken in the design of the new structure, 
 and the two cantilevers had been successfully erected without 
 serious accident. The plans for the supported span in the center 
 and for raising it into place had also been carefully studied, and 
 were thought to be beyond suspicion. When the span was being 
 raised, however, after it had been raised a few feet and the scows 
 had been taken away, there was a sudden failure at the southeast 
 corner support, and the entire supported span dropped into the 
 river. 
 
 The lecture explained by means of numerous lantern slides the 
 construction of the bridge, the methods of erection, and the causes 
 for the failure. The cause is considered by some to have been a 
 flaw in a steel casting, but it is more probable that the stress in 
 the casting was excessive. Nevertheless, the other three castings 
 held, and it is possible that there may have been a flaw in the 
 
one that failed. The design of these castings, however, was shown 
 to be open to criticism, and the peculiar point was illustrated that 
 while more material was put into them than was necessary the 
 result was a decrease' in strength. 
 
 Following this failure a new central supported span was built, 
 and in the following year it was successfully erected, so that the 
 structure is now complete. In the erection of the final structure 
 the methods which were considered open to criticism in the pre- 
 vious structure were changed. 
 
 [Third Lecture] 
 
 RAPID TRANSIT IN CITIES AND THE MEANS OF 
 OBTAINING IT 
 
 This lecture dealt with the subject of the growth of urban 
 population, the transportation problems to which this growth 
 had given rise, and the methods of meeting these problems. The 
 lecture was illustrated by a large number of lantern slides show- 
 ing subways and elevated structures in various American and 
 foreign cities. 
 
 The two main methods of providing rapid transit in cities are 
 by means of subways and elevated lines. The first subway in the 
 United States was built in Boston, and the lecturer had been 
 connected as a member of the Boston Transit Commission with 
 the construction of all the Boston subways for the previous 
 twenty-five years. The relative advantages and disadvantages 
 of subways and elevated lines were discussed, the relative costs 
 compared, and the methods of construction described. 
 
 [Fourth Lecture] 
 
 THE PRESENT SITUATION WITH REGARD TO THE 
 
 DEVELOMENT OF WATER POWER AND FEDERAL 
 
 LEGISLATION ON THE SUBJECT 
 
 There are few points of more practical interest to the people 
 of this country than the development of water power. In this 
 subject the people of the Pacific Coast should be particularly 
 interested, inasmuch as they are comparatively remote from 
 
deposits of coal, although, of course, they have large supplies of 
 that other fuel, which has taken so large a place in industry in 
 recent years. 
 
 Power is one of the great necessities of modern civilization. 
 Indeed it may fairly be said that this modern age may be charac- 
 terized more accurately than in any other way as an age of the 
 development and use of power. When we remember that it is 
 only one hundred and fifty years or less since the invention of 
 the steam engine, that the locomotive is not yet one hundred 
 years old, that the telephone, electric light, all forms of electric 
 energy, and practically all of our modern machinery have been 
 developed within one hundred and fifty years, prior to which 
 time almost all manufacturing was done by hand, is it not clear 
 that this is an age primarily of power and machinery? 
 
 The sources of power are two, viz. : the combustion of fuel, 
 and the harnessing of the natural power developed by falling 
 water. These two sources are fundamentally different in their 
 economic significance. Every pound of fuel that is burned is 
 permanently lost to mankind and can never be recovered. Con- 
 servation of fuel means economy and restriction in its use. Seeing 
 that the end of our fuel supplies must come at some time, perhaps 
 in the not very distant future, it is essential that the greatest 
 possible economy should be exercised in its use. The power of 
 falling water, on the other hand, is generated constantly by our 
 rivers as they flow from their sources to the sea, and only needs 
 to be harnessed in order to be utilized. Every pound of falling 
 water not harnessed or used is lost forever and can never be 
 recovered, although providentially the power goes on perpetually 
 from year to year, renewing itself constantly. 
 
 Conservation of fuel, therefore., means the greatest possible 
 restriction in its use : conservation of water power means the 
 greatest possible extension of its use. Every horse power devel- 
 oped by water not only provides that power for use, but elim- 
 inates development of power by means of combustion and per- 
 manent loss of fuel. Conservation of water power is therefore 
 a double conservation ; it saves not only the power itself, which 
 otherwise runs to waste, but it prevents or replaces the develop- 
 ment of power by the use of something which once used can never 
 be replaced. 
 
There is a third element involved, which makes the use of 
 water power a triple conservation. Much has been said in recent 
 years with reference to the desirability of improving our means 
 of inland navigation by making our rivers navigable. In general 
 this can only be done by means of locks, dams, and canals, by 
 which a river is converted into a series of pools, or reaches, in 
 which the velocity and depth are sufficient for navigation. Most 
 projects for inland navigation are, in the opinion of the speaker, 
 uneconomical and undesirable. Transportation by river and 
 canal has been outgrown and superseded by transportation by 
 rail, except in certain special localities, as, for instance, on the 
 Great Lakes and wherever long distances can be traversed by 
 water by means of large vessels. If anyone doubts this he has 
 only to read Professor Moulton's interesting book entitled 
 "Waterways vs. Railways," or Mr. John Howe Peyton's book 
 on railroad transportation in order to be convinced. Nevertheless, 
 much is said about inland navigation, and in some cases and for 
 small craft it is a desirable means of transportation. The point 
 now to be observed is that the development of- water power by 
 the building of a dam is a large step in making a river navigable. 
 The dam should, of course, be located not solely with reference 
 to the requirements of water power but also with reference to 
 the requirements of navigation. If so located, a water power 
 development is a navigation improvement. Conservation of water 
 power, therefore, not only develops power and prevents it going 
 to waste, but also conserves fuel and navigation, and is, therefore, 
 a triple conservation. At the present moment with the enormous 
 demand for fuel, its price is very high, and the supply is in- 
 sufficient for daily requirements. In the East there has been a 
 coal famine this winter, the seriousness of which is propably not 
 appreciated by those who live in the warm climate of California. 
 Many people have been unable to get coal enough to keep them- 
 selves decently or comfortably warm through a winter of un- 
 exampled severity. The coal supply has been doled out in baskets- 
 ful or bagsful under the direction of public committees, and our 
 coal yards have every day been crowded with anxious people 
 trying to get a few pounds to keep themselves warm. An ex- 
 mayor of the city in which I live, finding himself out of coal and 
 trying to get some was told by his dealer that the best he could 
 
do was to let him have one ton if he would send and get it. 
 Some people have had to close up their houses and live in hotels. 
 Factories have been obliged to restrict output at the very time 
 when it should have been increased to its maximum. Even in 
 Philadelphia, close to the coal deposits of Pennsylvania, there 
 has been much suffering and distress. 
 
 The situation indicates forcibly the need, in the interests of 
 the public and of the nation, of the greatest possible or practic- 
 able development of water power, for water power can be used 
 not only for power but for heat and light. Moreover, the intro- 
 duction of electrical transmission of power has made it possible 
 to develop water power in Inaccessible regions, where such power 
 exists, and to transmit it for use up to a distance of over two 
 hundred miles with very little loss in transmission. Previous to 
 the development of electrical transmission water power was under 
 the great handicap that it could only be used at or near the point 
 of development which is frequently in remote, mountainous, or 
 otherwise inaccessible regions. Electrical transmission has, there- 
 fore, revolutionized the status of water power and enormously 
 increased its importance. With the development of electrical 
 transmission has also come the increasing use of electricity as a 
 means of utilizing power. Electric light has become the almost 
 universal illuminant and electric motors are universally used to 
 drive our street cars and largely used to drive machinery in mills. 
 One of the great developments in the future will be its increased 
 use in operating our railroads by means of electric locomotives 
 instead of steam locomotives. Electric powder is also used in 
 many commercial processes, such as the manufacture of nitrogen- 
 ous products for explosives and fertilizers, and in other processes 
 requiring the production of a high temperature. 
 
 In view of all the foregoing, it seems passing strange that 
 water power has not been utilized to a greater extent. It would 
 seem self-evident that the interests of the public would require 
 its greatest possible economic development. Notwithstanding this 
 its development has lagged behind that of steam. The last census 
 of the United States in 1909 showed the total owned steam and 
 gas power in use in forty-three leading industries to be 14,950,525 
 horse power, and the total water power in use 1,822,888 horse 
 
10 
 
 power. Mr. Leighton, formerly Hydrographer of the United 
 States Geological Survey, states that the developed water power, 
 according to the census made in 1908 is 5,356,680 horse power. 
 Mr. Leighton estimates that the undeveloped water power 
 amounts to 37,000,000 horse power for twenty-four hours a day 
 and 365 days in the year, of which one-third is in the northern 
 Pacific region. Another government estimate is 28,000,000 horse 
 power. But the greater part of the undeveloped power is at sites 
 where at the present time there is no market. Mr. Leighton 
 further states that in his opinion "The available water power 
 sites in the country are all developed." It should be remarked, 
 however, that the electrification of our railroads would make 
 available a great many sites where otherwise there would be no 
 market. Moreover, many sites now developed might have the 
 power much increased if provision were made for proper storage 
 which would supply water during dry seasons. The increase in 
 power available by this means is very great, the absolute maxi- 
 mum power possible by development in this country amounting 
 in Mr. Leighton 's opinion, to "a conservative total of at least 
 200,000,000 horse power." 
 
 There is no question in the minds of those who have given 
 this problem careful consideration that there is in this country 
 an immense supply of water power possible of commercial de- 
 velopment if a market could be established, and that the electri- 
 fication of railways and the development of electro-chemical 
 industries may offer a market for much of this power. A large 
 part of the power within range of commercial development is in 
 the region of the Columbia River and the northwestern Pacific 
 slope. It is stated by good authority that "The largest amount 
 of water power in any one state is contained in the state of 
 Washington, which has nearly 10,000,000 water horse power, of 
 which less than three per cent has been developed. In Washing- 
 ton coal is mined and steam power plants are operated within 
 the range of the sound of descending waters, and trainloads of 
 coal are imported each day from British Columbia." The same 
 authority gives a list of actual projects for the development of 
 water power in navigable streams which have been held back 
 from development, amounting to 2,122,000 horse power. At all 
 events a very great amount of power is possible of development 
 
11 
 
 as an engineering proposition, and in view of the fuel shortage 
 its development and use should be carefully studied and encour- 
 aged in every reasonable way. 
 
 This subject has within the last three months been taken up 
 by the Chamber of Commerce of the United States through a 
 committee appointed for the purpose, and a referendum has been 
 issued to constituent members throughout the country briefly 
 discussing the subject and asking for a vote on certain funda- 
 mental principles involved. 
 
 In a recent consular report on the chemical industries of 
 Norway the following statement is made : 
 
 In surveying the chemical industries of Norway there are several 
 features worthy of careful study by the American economist. First 
 and foremost is the systematic and exhaustive manner in which the 
 abundant water power of the country is now being regulated, 
 stored up, and pressed into the service of the steadily increasing 
 group of the electro-chemical industries. The best talent of the 
 nation is enlisted in this cause and the way is rapidly being opened 
 for Norway to assume an industrial position commensurate with 
 its size and admirable facilities for maritime transportation. 
 
 Why should not the United States devote equal attention to 
 the development of its great resources ? 
 
 From the above figures and other available statements and 
 estimates it seems probable that there is today in use between 
 four and five times as much steam power as water power, and 
 that there is still undeveloped water power which could be 
 practically developed amounting to much more than all of the 
 steam power now in use. 
 
 The development of water power besides saving fuel and 
 affording a means of improving navigation, would bring other 
 important advantages. It would release for other service the 
 labor of millions of men employed in mining, transportation, 
 and distribution; it would release hundreds of thousands of 
 freight cars now used in transporting coal, as well as thousands 
 of locomotives; it would save much damage and inconvenience 
 due to smoke and soot, and thereby tend to improve human health 
 and cleanliness. 
 
 Every horse power than can be developed by water and used 
 to replace steam power saves in the neighborhood of $15 worth 
 of coal per annum. If this saving is capitalized at ten per cent 
 it .justifies an investment of say $150 a horse power in a water 
 
12 
 
 power plant in excess of a steam plant. If 10,000,000 horse power 
 could be developed by water this justifies an investment of 
 $1,500,000,000. There seems little doubt that at least 5,000,000 
 horse power could today be developed by water if encouragement 
 were offered. This would mean an annual saving of, say, 
 $75,000,000 in cost of coal alone. 
 
 Mr. Hugh L. Cooper estimates that the utilization of 35,000,000 
 horse power by water power would save, as compared with steam 
 power, the sum of $1,241,600,000 per annum, besides conserving 
 280,000,000 tons of coal and transferring to other needs the 
 service of 600,000 railway cars, 20,000 locomotives, and 740,000 
 laborers. 
 
 Why then has water power not been more developed ? There 
 are two reasons; first, the high cost of development of water 
 power and its inferiority to steam in most respects; second, 
 governmental restriction and discouragement. Let us consider 
 these two in some detail. 
 
 1. High Cost of Development of Water Power and Its 
 Inferiority to Steam in Most Respects 
 
 One of the fundamental mistakes in the popular conception 
 of water power is that it is cheap. The power itself is observed 
 running to waste and it is inferred that as the power is there and 
 does not require to be developed but only to be harnessed, it can 
 be utilized at small expense. Such a view is incorrect. 
 
 No power plant would be built, whether for steam or water, 
 except in the expectation that it would be profitable for its 
 owners, that is to say, that the gross return would be sufficient 
 to cover all charges and leave a net return of an amount sufficient 
 to be attractive. 
 
 With reference to the cost of power the charges to be deducted 
 from gross earnings are five, viz. : fuel, other operating expenses, 
 taxes, depreciation, and fixed charges. A water power plant has 
 the advantage that there will be no charge for fuel, and that 
 other operating expenses will be small. The taxes and depreciation 
 will be perhaps the same in either case, though v the depreciation 
 should be smaller, in general, for a water power plant. The fixed 
 charges, however, will be very much greater for the water power 
 
13 
 
 plant. It is not generally realized that the initial cost of a water 
 power plant will generally be from two to five times as much 
 per horse power as for a steam plant, and, furthermore, that the 
 initial development will have to provide for a larger total horse 
 power. This arises from the fact that the construction necessary 
 for a water power plant frequently, or generally, involves a dam, 
 which may be of great size, and a very large area of land which 
 must be flooded, and riparian rights acquired, together with 
 canals, pen stocks, flumes, or conduits, and sometimes of great 
 length, as well as transmission lines many miles in length, all 
 of which is in addition to the power house itself with its 
 necessary machinery. A steam plant is simple, involving simply 
 the buildings and land for them, with the necessary machinery. 
 The risk to the investor on account of the greater initial cost and 
 higher fixed charges is, therefore, much greater for the water 
 power plant than for the steam plant. Moreover, in case of 
 failure there is a greater salvage in the steam plant. The land 
 and buildings may be abandoned and used for other purposes, 
 for they are generally located near the point of utilization or 
 in a city, whereas a water power plant, like a railroad, can only 
 be used for the purpose for which it was designed and cannot 
 be abandoned and given up to some other use. The investor in 
 a water power plant must, therefore, be prepared to face fixed 
 charges of from two to five times that of a steam plant per horse 
 power; and this of itself would be sufficient to deter investors 
 from entering this field unless favorable conditions should exist 
 both as to development and utilization and freedom from undue 
 interference by public authorities. Furthermore, as already 
 stated, the initial development in a water power plant must be 
 greater relatively than in a steam plant. Most undertakings 
 grow from small beginnings. If steam power is used, a small 
 power plant may be built first, with one boiler and one engine. 
 If the undertaking is successful and the demand for power grows, 
 it is easy to add more units. In a water power plant, on the 
 other hand, the dam, reservoirs, tunnels and other conduits, must 
 be planned for a greater capacity than will be available at the 
 beginning, for it may be difficult, if not impossible, to increase 
 the capacity. The turbine wheels, of course, may be increased 
 
14 
 
 in number as the demand for power increases, but the other 
 elements, except the transmission line, are not so easily increased. 
 This element then also increases the initial investment and the 
 risk to the investor. There is still another advantage in a steam 
 plant, arising from the relatively greater possibility of improve- 
 ment in the efficiency of steam machinery. A water wheel will 
 utilize eighty or more per cent of the theoretical energy of the 
 falling water, and the loss in electrical transmission will be small. 
 There is, therefore, only a possibility of a slight increase in 
 efficiency due to improvements in the art, probably not over five 
 to ten per cent. On the other hand, in a steam plant the best 
 reciprocating engines or steam turbines develop but little more 
 than fifteen per cent of the theoretical energy of the coal and 
 the best gas engines something over twenty per cent. It is evi- 
 dent that the margin for possible increase in efficiency is very 
 great. As a matter of fact, notwithstanding the increase in the 
 cost of fuel, both the initial cost and the operating cost of steam 
 plants has decreased considerably within recent years. Not many 
 years ago a steam plant was commonly estimated to cost in the 
 neighborhood of $100 per horse power, while recently (before the 
 war, of course) large plants have been built at an initial cost of 
 $40 or $50 per horse power, and these plants are said to have 
 generated power for about three and a-third mills per kilowatt 
 hour exclusive of interest and depreciation, which means for con- 
 stant power twenty-four hours a day and 365 days in the year 
 about $22 per horse power. If to this we add twelve per cent, on 
 $40, for interest and depreciation on the initial cost, we arrive at 
 a total cost under $27 per horse power per annum under favorable 
 conditions, but varying, of course, very greatly, depending upon 
 the manner in which the power is used, whether constantly or 
 only during the day, the cost of fuel and labor, whether steam 
 is needed and used for other purposes, as for heating, processes 
 of manufacturing, etc. 
 
 Moreover, steam power is constant from day to day through- 
 out the year, while water power fluctuates, sometimes very 
 greatly. At periods of low water there may be very little power, 
 while at other times there may be a disastrous flood. The works 
 are liable to damage, and if the power to be developed is to be 
 
15 
 
 greater than the absolute minimum flow of the stream it must be 
 by storage, which can only be procured by means of reservoirs, 
 involving the taking and flooding of large areas. 
 
 Water power can be produced aside from fixed charges at a 
 lower cost than steam power, if the conditions are favorable, 
 owing to the absence of cost for fuel and the lower cost for labor ; 
 but the fixed charges on the much larger investment often suffices 
 to bring the total cost above that for steam power. 
 
 Summing up, the large initial cost of water power develop- 
 ments and the greater risk to the investor, together with the 
 greater proportional development required at the beginning, is 
 the main deterrent under this first heading to water power de- 
 velopment. Once safely financed and in operation, with a good 
 market, and fair treatment, water power developments are very 
 attractive on account of the greater convenience, the small operat- 
 ing expense, the small amount of labor employed, and the conse- 
 quent absence of labor troubles, the independence of fuel supply, 
 the smaller depreciation (in general), and the comparatively 
 small amount of working capital needed. These advantages, 
 however, may be more than offset if burdensome regulations and 
 restrictions are likely to be imposed by public authority. 
 
 It is a common impression that water powers are very profit- 
 able undertakings, which are being sought by capital as a means 
 of securing large returns on a small investment. Such is not the 
 case. It has been pointed out that the investment is large and 
 that in many respects steam power offers greater possibilities 
 for profit than water power. If water power is to be developed, 
 the conditions must be made favorable, and inducements must 
 be offered to investors, including reasonable assurance of fair 
 treatment from the public authorities. Present demand for the 
 development of water power and there is a large demand in 
 many localities generally comes not from capitalists who are 
 seeking for profitable investment, but more often from communi- 
 ties and industries which, on account of the high price and 
 scarcity of fuel, are desirous in their own interest of inducing 
 capital to make such developments; just as the demand for the 
 building of railroads in the early days arose quite as much, if 
 not more, from the desire of communities and states to secure 
 
16 
 
 transportation facilities in order to develop the public resources 
 as it did from investors who saw the possibilities of large returns. 
 
 The collateral advantages resulting from the development of 
 water power, viz., the saving in fuel, in labor, in transportation, 
 the absence of smoke and soot, are reaped not by the owners of 
 the water power but by the community as a whole. If the total 
 water power in the country now commercially capable of develop- 
 ment could be brought into use, there is no question that the total 
 direct and indirect saving to the public in the conservation of 
 fuel and the release of labor and railroad equipment, as well as 
 in other ways, would run into hundreds of millions of dollars 
 annually, perhaps billions of dollars. 
 
 The above considerations show the importance of approaching 
 the subject with an attitude of mind which recognizes that the 
 development of water power is of benefit mainly to the com- 
 munity as a whole, and that in order to secure such benefits 
 water power developments must be made attractive to capital, 
 rather than with the attitude of mind which assumes that such 
 enterprises should be surrounded with as many restrictions as 
 possible. Particularly is this the case at this moment in this 
 country. Capital will have abundant opportunities after this 
 war, both here and abroad. States, communities, and individ- 
 uals will be clamoring for it, and it will be comparatively scarce, 
 owing to the great destruction of wealth which has taken place. 
 There will also be a scarcity of labor unless the labor supply of 
 Oriental countries, which have not felt the devastation of war, 
 can be utilized, which seems to many desirable though it may not 
 appeal to some of you on the Pacific Coast. 
 
 This leads us to consider the second reason why water power 
 has not been more extensively developed, viz., 
 
 2. Governmental Restriction. 
 
 It is self-evident that large water powers will generally exist 
 on large streams on which navigation is possible and which come 
 within the category of navigable streams, or else in regions near 
 head water which may lie within the public lands of the Forest 
 Reserve. It is stated on good authority that of 77.2 per cent of 
 the water power resources of the country which require a Federal 
 
17 
 
 permit, less than 4 per cent has been developed, while of 22 per 
 cent of those resources which do not require a Federal permit 
 25 per cent has been developed. (This, of course, may be partly 
 due to inaccessibility, lack of market, etc.) As a matter of fact 
 many undeveloped water powers are in whole or in part under 
 control of the Federal Government, either because they are on 
 navigable streams or require the use of public lands. With 
 respect to these powers the policy of the Federal Government in 
 recent years has been such that their development, instead of 
 being encouraged, has been almost prohibited. I will endeavor 
 to briefly summarize the situation. 
 
 Federal Acts prior to 1899 had prohibited the building of 
 dams in navigable rivers in such manner as to obstruct or hinder 
 navigation or in places where they might interfere with actual 
 navigation until the plans for such works should be approved by 
 the Secretary of War. In 1899 an act was passed requiring the 
 consent of Congress for the building of such structures and the 
 approval of the plans by the Chief of Engineers and the Secre- 
 tary of War. Since the passage of this act it has been customary 
 to obtain a special act of Congress for the development of each 
 water power on navigable streams. These acts generally require 
 very properly that any changes which may be rendered necessary 
 if the structure is found to obstruct navigation in the future 
 shall be carried out by the owners at their own expense. 
 
 In 1906 the so-called General Dam Act was passed, in which 
 further restrictions were added, requiring the permittee to con- 
 struct, maintain, and operate at his own expense such locks or 
 other structures or appliances which the Secretary of War at 
 any time might deem necessary in the interests of navigation, and 
 that if Congress should authorize the construction of a lock for 
 navigation in connection with a dam, the owner should convey 
 to the United States, free of cost, the title to such land as might 
 be required, and should operate such locks, and maintain such 
 lights and signals, at his own expense, as the Secretary of Com- 
 merce and Labor should prescribe. These conditions were not 
 obligatory, but they might be imposed by the Secretary of War 
 at his option, although another section of the act allowed the 
 United States to construct and maintain locks or other struc- 
 
18 
 
 tures required for navigation at its own expense. The main 
 objection to the act, however, was that it was revocable by the 
 Government at any time. In 1910 the act of 1906 was amended 
 and still further restrictions added, providing for the collection 
 of a charge for any head-water improvements made by the 
 United States which might improve the flow of the stream, even 
 though the permittee did not profit by them. Any act was made 
 revocable at any time, but, if revoked, the United States was to 
 pay the owners the reasonable value of the works, as decided by 
 the court if not by agreement. Permits were to be given for a 
 period not exceeding fifty years. This last act was, therefore, 
 more fair to the permittee than that of 1906, because it provided 
 that if the rights should be revoked the owner should receive 
 compensation. It did not, however, provide for any compen- 
 sation at the end of the period of the lease, which could not be 
 greater than fifty years, nor for any renewal at that time. The 
 owner, therefore, who developed the water power would have to 
 amortize or receive back his entire capital during the fifty year 
 period. 
 
 It will be observed that by this last act the permit was re- 
 vocable at any time : if revoked the United States was to pay com- 
 pensation, and had a term not to exceed fifty years, without 
 compensation or renewal at the end of that period ; also that the 
 permittee might be required to give land for locks and to con- 
 struct and operate such locks at his own expense. Notwithstand- 
 ing the fact that by constructing the dam he made a large con- 
 tribution toward rendering the stream navigable, he was required, 
 or might be required to contribute still more. There was no 
 question as to the propriety of his paying for any benefit which 
 he might receive from head-water improvements, if he actually 
 received it. The government also reserved the right to alter and 
 amend the act at any time. Any riparian owner building a dam 
 for power purposes, therefore, placed himself entirely at the 
 mercy of the Federal Government. But even these restrictions 
 were not sufficient for those entirely well-meaning and enthusi- 
 astic persons who maintained that the government should not 
 give away any of its rights on navigable streams or on the public 
 domain, but who failed to perceive the importance of encourag- 
 
19 
 
 ing water power development. They maintained that, in addi- 
 tion, the permittee should be charged for the power developed. 
 They insisted on the imposition of such charge, together with the 
 other burdens referred to, being placed upon riparian owners who 
 desired to utilize their natural riparian rights and incidentally 
 to confer a considerable benefit upon the government without 
 expense to it by improving the navigability of the stream. Sev- 
 eral bills providing for the construction of dams across navigable 
 streams were vetoed in 1908, 1909, and 1912, because they con- 
 tained no provision for compensation, or because the act of 1906 
 did not terminate the permit at some fixed time. There was 
 great difference of opinion in Congress regarding these matters, 
 and in general it may be said that Congress was in favor of 
 greater liberality toward permittees, while the executives believed 
 in restriction. In 1913 a bill to permit the construction of a 
 dam for water power purposes across the Connecticut River, 
 which provided for compensation to the government, to which the 
 applicants for the privilege had agreed, was defeated in Congress 
 by the votes of those who were willing to give the company the 
 privilege without compensation but were unwilling to establish 
 the precedent or to recognize the principle that the government 
 is entitled to receive it. They believed that while it had the 
 power, it had not the legal or moral right to accept it. 
 
 Prior to January 30, 1912, the Federal Government expended 
 at the Des Moines Eapids on the Mississippi Eiver the sum of 
 $1,458,103 for inadequate navigation facilities, and prior to 
 June 30, 1912, the sum of $12,184,987 for navigation improve- 
 ments on the entire stretch of the river between the mouth of 
 the Missouri and St. Paul. Since 1910 the Mississippi River 
 Power Company as a private investment has expended upward 
 of $20,000,000 at the Des Moines Rapids, and has constructed a 
 magnificent dam with locks of deep draft. 
 
 On the Coosa River in Alabama, which is navigable in its 
 upper and its lower portions, but not in an intermediate distance 
 of about one hundred miles, in which improvements by the gov- 
 ernment have been considered impracticable on account of the 
 expense, navigation improvements had cost prior to 1876 about 
 $1,500,000. Under an act of 1907 a water power dam has been 
 
20 
 
 constructed without expense to the government at a cost of over 
 $2,000,000, and in 1912 a similar improvement was proposed at 
 another place at nearly the same cost. This was vetoed because 
 no compensation was provided. In this case the applicants pro- 
 posed to build a nitrate plant, producing a product valuable for 
 fertilizers or explosives. If this bill had not been vetoed, this 
 country would have had a nitrate plant today. As it was, when 
 the permit was refused the applicants went to Canada and 
 located their plant there. 
 
 Similar restrictions have been urged upon the government 
 and adopted with reference to the development of water power 
 on the public domain. Here it is, of course, proper that if gov- 
 ernment lands are used the permittee should either pay for them 
 outright or pay a reasonable annual charge. Where, however, 
 the public domain is only incidentally affected, as, for instance, 
 where some portion of it would be flooded by the pond created 
 by the dam, or where government land is crossed by flumes or 
 transmission lines, if water power development is to be encour- 
 aged it is desirable that the permittee should acquire a permanent 
 right or that, at all events, he should not be subjected to any 
 onerous restrictions. This case, however, according to present 
 regulations is treated just the same as the case where the govern- 
 ment owns the site of the power itself. The main obstacle to 
 development in these cases does not arise from the rates which 
 are charged, which are generally reasonable, but from the form 
 and condition of the permit, which at present is revocable at any 
 time at the will of the government department by which it is 
 granted, and also subject to other deterrent restrictions. Can 
 you imagine that investors will knowingly put their money into 
 water power developments if the fact that a small part of the 
 transmission line which may lie upon government lands subjects 
 the entire development to the charge of instant revocation of its 
 rights upon the whim of a cabinet officer? As a matter of fact, 
 on March 2, 1909, the Secretary of Agriculture and the Secretary 
 of the Interior did revoke some twenty-five permits, substituting 
 permits with different conditions. It may be that the revocations 
 in this case were not made for the purpose of embarrassing the 
 permittee, but were to meet altered conditions; but the fact 
 
21 
 
 remains that permits could be revoked and have been revoked at 
 the pleasure of a cabinet officer, and that the revocations made did 
 embarrass the permittee. 
 
 Among the other provisions with reference to water powers on 
 the public lands which hinder the development of power are the 
 following : If the government takes the property, the price paid 
 is to be fixed by the government or by a member of the cabinet. 
 It is sometimes provided that a company operating under a gov- 
 ernment permit shall not sell more than fifty per cent of its 
 power, or some other percentage, to any one concern. How could 
 railroad electrification be promoted under such restrictions? 
 Rental rates, which, as we have stated above, are properly im- 
 posed, may be revoked by the Secretary and new ones imposed at 
 periods of not less than ten years. In imposing new rates, appre- 
 ciation in land values is considered as income in estimating a 
 fair return to the investor, who, of course, never receives this 
 appreciation, since the land is used and necessary for the works. 
 Notwithstanding this, in case the property is taken by the United 
 States or by state or municipal corporations only the original 
 cost of the tangible property is to be paid to the owner. He is 
 here not to be allowed the appreciation of land. 
 
 The inadequacy of the present laws to encourage water power 
 development has been recognized by several cabinet members 
 directly concerned, who have referred to them as "absolutely 
 inadequate and thoroughly unsound in principle and practice." 
 Please remember, then, that the present defects of water power 
 legislation may be summed as follows, as outlined in the report 
 of the committee of the Chamber of Commerce of the United 
 States : 
 
 Water Powers on the Public Domain 
 
 As to water powers on the public domain (lands the title to 
 which is in the United States), a permit has to be obtained from 
 the Department of Agriculture or the Department of the Interior, 
 whichever has control over the site in question, and, no matter how 
 much the investment required, the permittee must accept a permit 
 which is upon the face and in fact, arbitrarily revocable at any 
 time, that is, revocable by the same department that grants the 
 permit. His permit also may be made subject to any conditions 
 which the department may see fit to impose at the time the permit 
 is granted. But this is not all, for his permit is made subject to 
 any further condition which the same department may at any time 
 choose to impose, adding further burdens or restrictions even after 
 
22 
 
 his investment has been made. Indeed, if a homesteader happens 
 to make entry upon the land covered by the site occupied by the 
 investor's water-power plant, then immediately the permit is, by 
 virtue of such entry, automatically revoked. And in neither case is 
 the investor protected by provision for compensation. His entire 
 investment is at the hazard of loss or confiscation from the moment 
 it is made. 
 
 Again, even if the water-power site is located outside of the 
 public domain and it becomes necessary to use or cross any part of 
 tne public domain for a transmission line or otherwise, then, no 
 matter how slight the use, a permit must be gotten for such use, 
 and the same hazard of revocation prevails as in the case of a 
 permit for a public domain site. 
 
 The result is that, out of about 5,000,000 kilowatts of energy 
 commercially feasible to be developed from the water powers upon 
 the public domain, only about one-tenth have been developed. 
 4,500,000 kilowatts of energy on the public domain are unneces- 
 sarily and unreasonably allowed to continue to waste, because the 
 legislative restrictions and hazards prevent the necessary invest- 
 ment of private capital. 
 
 Water Powers on Navigable Streams Outside the Public Domain 
 
 Under the present status (Acts of 1906 and 1910) applying to 
 water powers outside the public domain, the term of the permit 
 cannot exceed fifty years, and at the end of that time the permittee 
 has no rights whatever. No consideration is taken of the length of 
 time required to build up his business and to get on a profit-paying 
 basis, nor of the necessary investment to keep his plant up-to-date. 
 At the end of the 50-year term, or a shorter term if it were made 
 shorter, he must lose his entire investment. To save himself from 
 this loss he must amortize his plant, which is impossible; that is, 
 he must add to his charges for service such amounts, beyond the 
 otherwise ordinary charges necessary to bring a fair profit, as are 
 sufficient to pay him back by the end of his term his entire invest- 
 ment. Tn many instances this would make his charges beyond the 
 rate which would bring a demand for his service. 
 
 But this is not his only hazard. His permit may be arbitrarily 
 revoked at any time before the end of his term, and that, too, 
 without compensating him adequately for his investment. More- 
 over, arbitrary conditions at the will of the War Department may 
 be imposed, and the nature and extent of the burdens or hazards 
 which may thus be arbitrarily imposed are left indefinite and un- 
 certain. Furthermore, he is subject to such conditions not only 
 imposed at the time and as a part of his permit, but it is also 
 subject to other indefinite and uncertain conditions and burdens 
 which may be imposed subsequently thereto. 
 
 This makes it impossible for any investor, acting under such a 
 consent of the Congress and a permit issued thereunder, to com- 
 pute with any business-like approximation the amount of the invest- 
 ment which he may ultimately be compelled to make. Of course, 
 where the investment-cost per horse power produced exceeds a fixed 
 sum, varying under various conditions, the enterprise is not com- 
 mercially feasible; that is, development and operation mean a loss 
 of profit and a loss of investment. These water-power developments 
 require large capital and careful financing, all of which is impos- 
 sible in the face of these uncertainties and hazards before which 
 capital necessarily shrinks. There have been developments on 
 
navigable streams within the past few years, but none of these has 
 been made under any permit granted under act of Congress since 
 1907. These developments are under consents granted under prior 
 acts. 
 
 These are the reasons for the present stagnation of water-power 
 development on navigable streams in this country. The legislative 
 defects now existing are apparent and not denied by any sane 
 student of the subject. 
 
 The present administration appears to recognize the difficulty 
 and is endeavoring to deal with it. The Committee of the 
 Chamber of Commerce of the United States, as above stated, has 
 prepared a referendum. This committee has made the following 
 recommendations : 
 
 1. As to all developments, whether within or outside the public 
 domain, a separate act of Congress should not as at present be 
 required for each development; but the authority to issue permits 
 should be vested in some department or commission designated for 
 that purpose and under conditions protective of the interest of the 
 public and of tne investor. 
 
 The advisability of this action has been generally recognized 
 by most students of the question. 
 
 2. Permits should be issued for a period of at least 50 years, 
 unless at the option of the applicant a shorter period is agreed upon, 
 and should be irrevocable, except for cause. 
 
 It will not be sufficient to fix the term of a permit as "not 
 exceeding 50 years. ' ' This would allow the government authority 
 to dictate a shorter period. Capital investments in water power 
 development should be allowed at least a 50-year period in order 
 to insure a reasonable average annual return, making up in later 
 years for losses incurred throughout the period necessary to 
 build up the business. A 50-year period is recognized very 
 generally among financiers as the shortest reasonable period for 
 such an investment. 
 
 3. A toll should be imposed by the government only on power 
 developments on the public domain or benefited by head-water im- 
 provements maintained by the government. Such tolls should be 
 based upon the horse power actually developed, used, and sold. The 
 tolls should be reasonable, and proportionate to the benefits actually 
 derived. 
 
 A distinction is not always recognized, as it should be, between 
 tolls exacted for permits for sites on the public domain and those 
 exacted under permits to develop power on navigable streams 
 outside the public domain. Tolls, as such, exacted for the pur- 
 pose of revenue, are not justifiable in reason or, according to 
 
LM 
 
 good authorities, in law when imposed under permits for the 
 improvement of navigable streams outside the public domain. 
 
 The government owns the public domain and when it grants 
 a permit for a site on the public domain it may reasonably exact 
 a toll, but a permit for a development upon a navigable stream 
 not on the public domain is simply a permit to improve rfparian 
 rights owned by the applicant, and the sole justification for even 
 requiring a permit in such a case is to protect the paramount 
 right of the government to regulate and protect navigation. On 
 such streams, therefore, a toll, if exacted at all, should be simply 
 in the nature of a license fee to cover the cost to the government 
 of such control and inspection of construction and operation as 
 are necessary to protect the interests of navigation. 
 
 In case the government makes improvements at the head- 
 waters of the stream, which improve its flow, and is, therefore, 
 beneficial to water powers below, it is proper that the amount of 
 such actual benefit received should be paid back, in part at least, 
 by all the users of water power, in order to reimburse the govern- 
 ment to some extent for the operation of the headwater improve- 
 ment. It is to be observed, however, that navigation interests 
 benefit by such headwater improvements equally with water 
 powers and perhaps more so, and that this benefit is given without 
 charge to those who profit from the navigation facilities, for the 
 federal policy regarding navigation is stated by the act of Febru- 
 ary 27, 1911, as follows : 
 
 No tolls or operating charges whatever shall be levied upon or 
 collected from any vessel, barge, or other water craft, passing 
 through any lock, canal, canalized river, or other work for the use 
 or benefit of navigation now belonging to the United States or 
 which may be hereafter acquired or constructed. 
 
 It is difficult to see why, in view of this provision, any toll, even 
 for headwater improvements, should be levied upon users of water 
 power; for it discriminates against them in comparison with 
 navigation interests, while, as a matter of fact, the development 
 of water power is much more beneficial to the public and ought 
 to be much more encouraged than the development of inland 
 navigation. 
 
 Any toll levied for headwater improvements should be accur- 
 ately defined. If stated as so much "horse power per annum" 
 
25 
 
 it is uncertain whether it is to be based on the number of potential 
 horse power possible of development at the site, whether or not 
 developed, utilized, or sold ; or whether on the basis of the actual 
 horse power generated at the site as a matter of fact, without 
 reference to the quantity utilized; or again, whether upon the 
 power actually developed, used and sold. The latter basis alone 
 should be the proper basis of the toll. The owner of the site 
 might have at his disposal already much more than he could find 
 a market for, and any headwater improvements might simply 
 result in a greater flow of water over his dam, without benefit 
 to him. Why, then, should he be taxed for such headwater im- 
 provements, which he has not asked for, does not desire, and 
 cannot use? 
 
 4. If public lands form only a small and incidental part of the 
 entire development, the licensee should be entitled to acquire the 
 right to use such lands, paying the government fair and just com- 
 pensation for such use. 
 
 One of the greatest obstacles to development of water power 
 on the public domain in cases where it is necessary for a trans- 
 mission line or pipe line to cross a small portion of government 
 land, but in which the site of the power itself is not on the 
 public domain, is the impossibility of obtaining any assurance 
 from the government that he can get the necessary rights, under 
 any reasonable tenure, which will assure him of security in his 
 investment. Any such slight use of government lands which may 
 be necessary to his enterprise may under present regulations 
 result in arbitrary revocation of his entire permit, and may, 
 therefore, mean the destruction of his entire investment. 
 
 5. At the expiration of the license period the government should 
 have the right to recapture the property for itself or for a new 
 licensee upon the payment of fair and just compensation for the 
 property and for all dependent property, if taken; and if the 
 dependent property is not taken, then fair and just compensation 
 should be paid for all severance damages. 
 
 Provision should be made that, all things being equal, the 
 original licensee have priority over any new licensee. 
 
 No great development of water will take place unless the 
 rights of permittees at the expiration of the permit are properly 
 protected. It seems clear that the government should have the 
 power to recapture the property at that time by paying for it its 
 fair value at that time. It should not have the power to take a 
 
26 
 
 portion of the entire property, leaving to the owner a portion 
 which is vitally dependent upon the portion taken by the govern- 
 ment, unless fair compensation is paid for the damage thereby 
 sustained. 
 
 6. At the expiration of the license period the government should 
 1^1) agree with the licensee as to the terms of a new license, (2) 
 recapture for itself or for a new licensee, or (3) continue the license 
 under the original terms. 
 
 If the government does not desire to take over the property 
 at the expiration of the license it is clear that it should be obliged 
 either to continue the license under the original terms or agree 
 upon new terms with the old licensee. It should not have the 
 power to force the old licensee to accept its own terms. 
 
 7. Rates and services should be regulated by state commissions 
 where the service is intrastate, and only by federal authority where 
 
 'the service is interstate and the commissions of the states which are 
 directly concerned do not agree or there is no state commission. 
 
 The exercise of any federal jurisdiction over the issuance of 
 securities would be unnecessary and unwise. 
 
 8. No preference should be allowed as between applicants, 
 whether a municipality or otherwise, which amounts to the granting 
 at the expense of the government of a subsidy creating- unequal 
 competition in the same market. 
 
 Some bills relating to this subject have proposed that muni- 
 cipalities or states should be granted permits without charge while 
 private parties must pay a toll. This would make it possible 
 after a private company had developed a power and was selling 
 it, for instance, for electric lighting purposes, for the muni- 
 cipality to develop another power and enter into competition 
 with the existing company, not only for municipal purposes but 
 for private purposes, which might result in the ruin of the 
 original company. It should not be possible for such a condition 
 to arise. It would mean putting into the market a competitor 
 subsidized at the expense of the government. It would mean 
 that a private licensee would under a government license expend 
 time and money to build up a market and business and when^ 
 perhaps after a long period, the time for making profits began 
 then the government would under another license give to a 
 municipal corporation, free of cost, other power with which, as 
 a competitor, to enter into a market already built up under 
 burdens of expense imposed by the government. There would bo 
 
27 
 
 competitors in the same market, the one under the burden of 
 expenditure imposed by the government permits, licenses or 
 leases, and the other subsidized either by a remission of capital 
 expenses or of tolls and, therefore receiving free of cost the 
 benefits of improvements paid for by the government. 
 
 In view of the benefits to the community which are brought 
 about by the development of water power, it is earnestly to be 
 hoped that action will soon be taken by Congress which, instead 
 of restricting, will encourage to the greatest possible extent the 
 investment of capital in these enterprises. Without any interest 
 in any of them and looking at the subject purely as a student 
 of public policy, the speaker has become convinced, especially in 
 view of the developments during this war, that it will be better 
 for the Federal Government to pay a subsidy to encourage the 
 development of water power and to remove all restrictions so far 
 as possible, always reserving to the government the power to 
 take over the property at any time in the future at its fair value 
 at such time. Perhaps when that time comes the courts will have 
 finally decided what fair value is, and how it is to be determined. 
 
 [Fifth Lecture] 
 
 SOME CONTROVERSIAL POINTS IN THE VALUATION 
 OF PUBLIC UTILITY PROPERTIES 
 
 The subject of the valuation of public utilities and other prop- 
 erties has come prominently into the public eye within two or 
 three decades. It has led almost to the formation of a new branch 
 of engineering, and has attracted the attention of many economists 
 and publicists. 
 
 The problem of estimating the value of an industrial property 
 is of course old. Bankers and business men have for many years 
 been obliged to attack it in order to form an opinion which would 
 justify purchase or sale, or the flotation of new securities, par- 
 ticularly since the era of industrial combination set in. But the 
 great increase in interest in the subject has been mainly the 
 result of the increasing regulation of public utilities by state and 
 national regulating commissions. When it was decided that 
 
28 
 
 public authorities could fix the rates to be charged by public 
 utility corporations, the question naturally arose at the outset, 
 upon what sum should the company be allowed to earn at least 
 a fair return ? "When it became necessary for a public board to 
 decide upon new issues of capital, or upon the proper total capital 
 to be allowed the company or upon the price to be paid for a 
 taking, the question naturally arose, what is the fair value of the 
 property represented? When it became necessary to allow a 
 company to earn a certain depreciation allowance, it was natur- 
 ally at once queried, upon what value shall such allowance be 
 reckoned ? 
 
 However, it is easy to go too far in the application of any 
 theory. There is clearly no relation between any particular 
 railroad rate, as, for instance, that between San Francisco and 
 Chicago, and the value of the property. The rate between com- 
 petitive points must be the same by all roads, independent of 
 value. The most that can be said of railroad rates is that if the 
 earnings as a whole, over a large district, are not sufficient to 
 give a fair return on the total value of the property, they should 
 be increased, and vice versa. Yet even here, some roads, by 
 virtue of low cost of construction or exceptional efficiency of 
 management, may prosper on the old rates, while other roads 
 may become bankrupt. The limits for the use of a valuation at 
 all is a subject for careful consideration. We are in danger of 
 forgetting that, in the words of Jefferson, "That country is best 
 governed which is least governed." May it not be that we are 
 regulating too much, and forgetting that after all, the principle 
 that rates should be determined by what the traffic will bear, 
 rightly applied, is perhaps the best? At all events, this principle 
 has been the one under which our railroad system has mainly 
 developed, and it has developed business and given us lower rates 
 and better service than in any other country on earth. 
 
 It is very generally assumed that the courts have decided that 
 a railroad company, or any public utility company, shall earn no 
 more than a fair return upon its property. This, however, is not 
 my understanding of the situation. I do not understand that the 
 Supreme Court has ever established that doctrine. The function 
 of that Court is only to decide whether any action violates the 
 
29 
 
 Constitution of the United States, and in rate cases to decide when 
 a rate is so low as to result in confiscation of private property. 
 In exercising this function I understand that it has decided that 
 one criterion by which to decide whether rates fixed by legislative 
 authority are so low as to deprive a railroad company of its 
 property without just compensation, according to the Constitu- 
 tion, is that if those rates prevent the company from earning less 
 than a fair return upon the present value of the property used 
 in the service of the public, then those rates are too low and 
 violate the Constitution. It has never decided that rates must be 
 fixed at such a point that only a fair return will be earned, and 
 it is easy to see that there may be other elements entering into 
 the problem. A railroad company experiences years of depres- 
 sion, during which earnings are less than normal. In order to 
 earn a fair return on the average it must, therefore, earn more 
 than a fair return in good years to balance the years in which it 
 will earn less, under any rate schedule; and, furthermore, it 
 must be allowed to earn a surplus, to provide for unforseen con- 
 tingencies, such as floods, earthquakes, etc. Rates cannot be 
 suddenly changed, as in the case of an industrial property, to 
 conform to varying conditions. A certain degree of flexibility 
 of rates, giving the opportunity to meet emergencies, now often 
 impossible under our regulating system, is much to be desired, 
 but, in general, rates should be stable. The basis of a fair return 
 upon the present value of the property used in the service of the 
 public seems, therefore, clearly to indicate only the minimum 
 return. 
 
 The Supreme Court, however, has distinctly said that if the 
 rates charged by a public utility corporation do not afford a fair 
 return on the fair present value of the property used in the 
 service of the public, those rates are confiscatory and therefore 
 unconstitutional. It becomes necessary, therefore, in many cases 
 to find such fair present value. 
 
 The term value is one of the most uncertain in the dictionary. 
 It may mean very different things. The problem of ascertaining 
 the present value of a complex operating property is consequently 
 necessarily one of those uncertain problems, partly depending 
 upon engineering facts, partly upon economic doctrine, and 
 
30 
 
 partly upon a perception of justice and equity as between the 
 public and the owners, in which almost every question, including 
 the desirability of a valuation at all, is involved in controversy ; 
 while upon some fundamental principles .the opinions of those 
 who might be deemed equally capable of forming a judgment 
 may differ widely. It is, therefore, not a subject to be dealt with 
 by the young, the immature, or the prejudiced. It is not a proper 
 subject for the college curriculum, except for selected students 
 in graduated courses. It calls for the power of logical, careful 
 reasoning, for experience, for good judgment, and above all for 
 a well balanced mind, fair and impartial, which sees things as 
 they are, has no prejudices, appreciates the wide bearings of 
 the subject, can judge of remote consequences, can disentangle 
 conflicting threads of argument, and can take the broadest and 
 sanest view of the relations of the public to the individual. The 
 problems of valuation are indeed more dependent for a correct 
 solution upon attitude of mind and capacity for logical thought 
 than upon anything else, and next upon experience, that great 
 and only teacher. 
 
 Where almost every point involved is the subject of contro- 
 versy and difference of opinion it is difficult to select any special 
 points for discussion ; yet it seems not inappropriate to choose 
 a few of the fundamental principles, and to outline some of the 
 main differences between opposing points of view. I do this the 
 more readily because of the increasing popular attention that 
 the subject is attracting, and in the hope that if some of you have 
 not yet thought deeply upon these questions it may suggest some 
 ideas, and indicate to you the many uncertainties of the subject 
 and the necessity for careful consideration of many points of 
 view before arriving at a conclusion. My own personal views 
 are, naturally, strenuously opposed by those who think differently. 
 My only excuse for speaking of this subject lies in its increasing 
 popular importance, and in the fact that circumstances have 
 called upon me, during the past ten years, to make valuations of 
 property aggregating nearly two billion dollars in value, so that, 
 at all events, however I may lack in judgment or sanity I cannot 
 be charged with inexperience. 
 
31 
 
 As a primary basis for ascertaining fair present value the 
 following are available: 
 
 1. The cost of the property to date ; new, or after deduct- 
 ing depreciation. 
 
 2. The cost of reproducing the property at the present 
 time; new, or after deducting depreciation. 
 
 3. The market value of its securities. 
 
 4. The capitalized earnings. 
 
 The basis of the commercial value of a public utility, or of 
 any other commercial property, is plainly earning power, present 
 or potential. No one would willingly invest in or buy such a 
 property unless he could see the prospect of a fair return. It 
 might be earning nothing, or even losing heavily at the time, but 
 he might not see possibilities of readjustment, improvement, or 
 additional business, or other possibilities which would justify 
 him in paying a considerable sum for the property. Most public 
 utilities are naturally and properly monopolies. It is not in the 
 interests of the public in the end that two railroads should be 
 built in the same territory where one is ample for the business. 
 If two exist, they must to a certain extent, in the public interest, 
 be operated as a combined monopoly. The days of unrestricted 
 competition have passed. But a public utility is a monopoly 
 which derives its power in part from a charter or rights conferred 
 upon it by the public. It must, therefore, be subject to public 
 regulation, and must be operated in such a manner that none of 
 the rights of the public, legal or moral, will be infringed. In a 
 certain limited sense it is the agent of the public which has con- 
 ferred upon it the right to perform a certain service which the 
 public requires. 
 
 The Supreme Court has recognized the above four primary 
 elements in ascertaining fair value, together with other elements 
 not here mentioned. In rate cases present earnings cannot, of 
 course, be considered as a basis, because the object is to fix the 
 rates and the earnings depend upon the rates. Some other basis 
 must here be found. The market value of the securities can be 
 found at any time by an accountant. They may, however, be 
 temporarily and unduly inflated or depressed, so that the market 
 value at any given time may not represent the value of the 
 
32 
 
 property. There remain the other two bases of value, viz. : the 
 original cost and the cost of reproduction ; and the first point to 
 which I wish to direct your attention is the great difference of 
 opinion which exists with reference to these two methods of 
 finding value. Each has its ardent advocates. It is claimed on 
 the one hand, in favor of original cost, that this represents the 
 sacrifice which the owners have made to produce the property, 
 and that they are entitled to a fair return upon no more than this 
 sum, or, if the property is taken, to a payment of no more than 
 this sum. 
 
 As one college economist expresses it, 
 
 On any sound principle there should be no valuation for rate 
 regulation but history, that is, a statement of outlay, of money 
 spent and services rendered, nothing more. ... As an agent the 
 utility exercises the right of eminent domain, must give an account 
 of its stewardship, is subject to continuous control, is liable for 
 compulsory service, and must cooperate with all other public agents 
 of its principals, the State. 
 
 It is held by this writer, and by some others, that the relation 
 between the public and the utility company is strictly the legal 
 relation of principal and agent. Your able California attorney, 
 Mr. Max Thelen, among others, takes this view. The advocates 
 of this view hold that the agent is only entitled to receive his 
 expenses and fair compensation for his services, and that if he 
 makes a profit he "may be held as a trustee and compelled to 
 account to his principal for all profits and advantages acquired 
 by him out of the relationship." This leads them to the con- 
 clusion that a public utility should receive a return only "on the 
 money reasonably and properly expended in the acquisition and 
 construction of its works actually and properly in use to carry 
 out its agency, no more and no less." If lands were donated by 
 the State to the company to enable it to construct its works, the 
 company is not to be allowed to earn any return upon those lands 
 when they have become valuable, or if it acquires lands at a low 
 cost it is only to be allowed a return upon such actual cost. 
 
 On the other hand, this view is rejected by most students of 
 the subject. It seems far-fetched and fanciful to most people, 
 and it has never had the sanction of the highest courts. Those 
 who oppose it urge that while a public utility may be termed in 
 a limited sense the agent of the public, it is in no sense a legal 
 
33 
 
 agent. The conclusions above stated clearly do not follow when 
 the principal has allowed that agent to manage the property for 
 years without supervision or restriction and perhaps at a loss, 
 and without a definite understanding at the beginning as to the 
 legal relation between the parties, has allowed it to charge what 
 rates it pleased, subject to competition, to earn what profits it 
 could, to go through bankruptcy, perhaps several times, without 
 interference by the principal. They urge that rights were given 
 to the company by its charter because those rights were necessary 
 to enable the works to be constructed, for without the power of 
 taking land by eminent domain it would probably be practically 
 impossible to construct a railroad. They urge that public lands 
 were given originally in some cases because without giving them 
 the public could not induce the company to build the works, and 
 that once given they are the property of the company, like any 
 other private property; they maintain that the public desired 
 the works to be built because it saw that 1Jiey were essential for 
 the prosperity of the State, but that the risk of loss was left 
 entirely with the company, and, therefore, that it should have 
 the ownership of its property and the possibility of profits when 
 they become possible. They say that lands originally given to 
 the company by the state were given absolutely, without con- 
 dition or agreement, that they were intended to be, and have 
 always been considered to be the obsolute property of the com- 
 pany, that they were given, as a matter of fact, in consideration 
 of advantages which the public expected to receive in compensa- 
 tion and which the public has actually received manifold in 
 compensation. They say that if the company was merely the 
 legal agent of the public that relationship should have been estab- 
 lished and understood by both parties at the beginning, which 
 has never been the case. They say that if the legal relation of 
 principal and agent is to hold, the agent must be subject to the 
 continual supervision of the principal, and that after allowing 
 a railroad company to manage its own affairs for decades, to go 
 through foreclosures and receiverships without any guarantee 
 of protection against loss on the part of the principal, it is in- 
 equitable and illegal for the principal at a later time to step in, 
 claiming that the legal relation of principal and agent is to be 
 assumed and that the company, after it has become prosperous, 
 
34 
 
 is then to be allowed to earn no more than a fair return upon 
 the original cost. 
 
 Moreover, the highest courts have stated, again and again, 
 that while it is at least the present value of the property which 
 the company employs for the public convenience which is entitled 
 to a fair return in rates, or to be paid as compensation in a 
 taking, this fair value is not the original cost thereof. For 
 instance, in San Diego Land and Town Co. vs. Jasper, 189 U. S. 
 442, the court said: 
 
 The main object of attack is the valuation of the plant. It no 
 longer is open to dispute that under the Constitution what the com- 
 pany is entitled to demand in order that it may have just com- 
 pensation is a fair return upon the reasonable value of the property 
 at the time it is being used for the public. San Diego Land and 
 Town Co. vs. National City, 174 U. S. 793-757. 
 
 That is decided and is decided as against the contention that 
 you ought to take actual cost of the plant, annual depreciation, etc., 
 and to allow a fair profit on that footing, over and above expenses. 
 
 Again, in the Minnesota Rate Cases, 230 U. S. 454, the court 
 said : 
 
 It is clear that in ascertaining the present value we are not 
 limited to the consideration of the amount of the actual investment. 
 If that has been reckless or improvident losses may be sustained 
 which the community does not underwrite. As the company may 
 not be protected in its actual investment, if the value of its prop- 
 erty be plainly less, so the making of a just return for the use of 
 the property involves recognition of its fair value if it be more 
 than its cost. The property is held in private ownership and it is 
 that property and not the original cost of it of which the owner may 
 not be deprived without due process of law. [Italics mine. G. F. S.] 
 
 The advocates of the original cost theory are always careful to 
 remark that the first cost is not to be taken if the company has 
 been wasteful or extravagant, that is, if the value is less than 
 that cost ; but they strenuously oppose making any additions to 
 that first cost if the investment has been skillfully made and has 
 resulted in an increased value to the property. 
 
 As a matter of fact, the first cost theory does place a premium 
 upon and encourage wasteful, extravagant, and inefficient con- 
 struction. Every engineer knows that there is a wide range 
 within which the cost of construction may be reasonable. In a 
 case in which the speaker was recently consulted there were four 
 bids for constructing a certain property, all by responsible and 
 skilled contractors. The highest three bids were close together, 
 although there was no evidence of collusion, and were double the 
 
35 
 
 lowest bid. The latter proved to be too low, and the contractor 
 lost money; his actual cost being about two-thirds that of the 
 highest-bidder. Even the highest bid could not have been con- 
 sidered an unreasonable one. 
 
 When a railroad is constructed it is given certain rights by 
 the public, but those rights are only those which are necessary 
 in order to secure the construction. A railroad is given the right 
 of eminent domain because without that right it would be im- 
 practicable to build the road. So of the right given to a street 
 railway company to lay its tracks in the streets, or to a gas com- 
 pany to lay its mains in the streets. The public grants the 
 rights because it wants the commodity which the utility is to 
 furnish. Not infrequently it is more anxious to grant the charter 
 than the company is to receive it. It leaves the company un- 
 restricted for many years in the conduct of its business and in 
 its financial management, and finally comes in to regulate it and 
 to fix its value. In the meantime the community has grown, 
 lands which perhaps were donated to the company have increased 
 in value in common with all other lands in the neighborhood, 
 largely due to the presence of the utility, and now it is said by 
 the advocates of original cost that since those lands were donated 
 to the company it is not to be allowed to earn any return upon 
 the value of those lands, because the public should not be required 
 to pay any rates for what it has itself given. In the meantime 
 the property may have changed hands a dozen times at prices 
 determined by the competitive theory, that is to say, based upon 
 the earnings which the public has allowed the company to make 
 without restriction. The original company may have been suc- 
 ceeded several times by new companies. Nevertheless, they claim 
 it is now to be allowed to earn a return only upon the original 
 cost, notwithstanding the decisions of the courts that costs is not 
 value. 
 
 The decisions of the courts are no stumbling block in the way 
 of some of those who advocate this theory, and one of them, a 
 college economist, sweeps the difficulties away by saying that the 
 present uncertainties and unsatisfactory condition are due to 
 these decisions of the Supreme Court and that they will continue 
 until that Court is compelled by public opinion to reverse itself 
 or until its power is changed by constitutional amendment. This 
 
36 
 
 illustrates the character of much of the discussion on this ques- 
 tion. The author referred to evidently considers that he and he, 
 alone, and those who agree with him, are infallible, that anybody 
 who disagrees with him is wrong, including the Supreme Court 
 of the United States, which must be compelled to reverse itself. 
 
 In connection with the original cost theory it is also asked by 
 some, in case its value is to be ascertained on the basis of first 
 cost, just what is meant? The first cost to whom? To the 
 owners, or to previous owners? If your property is to be taken 
 from you on the basis of its original cost, should that be its cost 
 to you or to somebody else? It is urged, for instance, that cer- 
 tain individuals might get together, obtain a franchise, and build 
 a railroad. They may be shrewd and far-sighted, may locate the 
 road with exceptional skill, and may build it under exceptionally 
 favorable conditions when prices are very low, or perhaps when 
 they can get certain of the work done at prices which can never 
 be again obtained. For instance, they may be able to get a 
 good deal of their grading or filling done for nothing, or they 
 may even be paid for it, for somebody else at the moment may 
 have a large quantity of earth, taken perhaps from a subway or 
 tunnel in a city, which he wants to dispose of, and unless he can 
 dispose of it to the utility he will have to pay a large sum to 
 carry it elsewhere. He may, therefore, be willing to dispose of it 
 to the utility and to place it for next to nothing or even to make 
 a payment therefore. At all events, the road may be supposed to 
 be constructed at an extremely low cost. It fills a need and 
 develops a good business, and a few years afterward some new 
 parties appear and seeing that it was built most economically 
 and has great possibilities, they may buy it from the original 
 builders at a large advance over what the latter paid for it, and 
 yet perhaps less than it would cost them at the time to reproduce 
 it, or to build another road. They buy it at that price. Years 
 go by and the property becomes subject to public regulation, and 
 is now to be taken for public purposes, or its rates fixed. Is it 
 equitable to pay the new owners what they paid for it or what 
 their predecessors paid for it? 
 
 Of course the answer which is made to this suggestion by those 
 who hold the theory of principal and agent is that the agent of 
 the public is the company and not the individuals who happen to 
 
37 
 
 own it and hence individual ownership is of no consequence. 
 But how is this when not simply the stockholders have changed, 
 but when the original corporation has been suceeded by a new 
 one ? Is the new corporation the agent, or not ? If it is, then the 
 cost to it should be taken ; if it is not, the whole theory falls. 
 
 The case, however, is certainly not so simple as some would 
 make it appear, nor can it be decided offhand by simply asserting 
 that the Supreme Court is all wrong. Certain it is that the 
 theory of principal and agent, and the use of first cost, if applied 
 as some have urged that it should be applied would very likely 
 wipe out millions of dollars of investment honestly made and 
 even sanctioned by regulating commissions. 
 
 Moreover, the theory of first cost, it is claimed, leaves entirely 
 out of account the element of competition, which still remains 
 to a certain extent, though under regulation. There may be two 
 railroad lines between the same two cities, and extending no 
 farther. One of them necessarily has the best location and 
 originally cost much less than the other. If the rates are to be 
 based upon original cost the more cheaply built road will obtain 
 all the business, and the building of new roads will be absolutely 
 prevented. This argument, of course, applies equally to the cost 
 of reproduction theory, and indicates that as a basis for rates 
 neither result is at all conclusive. Would this not be true equally 
 in case of a taking? If the public should take the more econom- 
 ically built road at its original cost it would thereby become pos- 
 sessed of an asset with which it could wage war against the later 
 and more expensive road, to the extermination of the latter, 
 although it had chartered it and was equally its principal. It is 
 asked whether the state should use its paramount powers to ruin 
 agencies that it has itself authorized. To many it is clear that 
 no valuation has much, if any, relation to rates, which should be 
 determined by what the traffice will bear. 
 
 By some it is considered that public ownership is the only 
 solution of these problems, but the experience with public owner- 
 ship is decidedly against its advantage to the public, and especi- 
 ally in a democracy it would be a distinct public menace. 
 
 Another consideration is urged with reference to the original 
 cost theory. If the basis of this theory is that it is the sacrifice 
 made by the agent which is the basis of value, it must be his 
 
38 
 
 total sacrifice, and if in any years of the enterprise he did not 
 receive a fair return on his investment any deficiency below a 
 fair return must be added to that investment and compounded 
 from year to year. Additions of this kind may easily result in a 
 great increase above the original cost investment. Moreover, it 
 is not only the cost of the property that is to be taken but also 
 the cost of developing the business to its present condition, 
 including all expenditures, direct or indirect. 
 
 Your able California attorney, Mr. Thelen, appears to hold 
 this view, for he quotes with approval from a decision by another 
 eminent Californian, Secretary Lane, who in the Western Ad- 
 vance Rate Case said : 
 
 Perhaps the nearest approximation to a fair standard is that of 
 bona fide investment, the sacrifice made by the owners of the 
 property, considering as part of the investment any shortage of 
 return that there may be in the early years of the enterprise. Upon 
 this, taking the life history of the road through a number of years,, 
 its promoters are entitled to a reasonable return. This, however, 
 manifestly is limited, for a return should not be given upon waste- 
 fulness, mismanagement, or poor judgment, and always there is 
 present the restriction that no more than a reasonable rate shall 
 be charged. 
 
 Those who oppose the original cost method fail, however, to 
 see why Mr. Lane should limit the shortage of return to the early 
 years of the enterprise, or why every shortage from the beginning 
 to the time of decision should not be allowed. They maintain 
 also that if from the original cost is to be deducted any losses 
 due to "wastefulness, mismanagement, or poor judgment," then 
 there should also be allowed any profits accruing from economy, 
 efficient management, and good judgment; and admitting that 
 there is always present the restrictions that no more than a 
 reasonable rate shall be charged, which Mr. Lane implies is a 
 restriction independent of first cost, they claim that this means 
 also that no less than a reasonable rate shall be charged, that is, 
 a reasonable recompense for the service rendered, also entirely 
 independent of first cost. 
 
 Against this view that deficiencies of earnings should be in- 
 cluded in original cost, it is urged by some that the mere physical 
 property would be worth nothing aside from its operation, that 
 the construction of the property means constructing a property 
 that has, or is capable of having, business, but which without 
 
39 
 
 the business is valueless. Giving the physical bare bones a value 
 is only justified, they say, if it has the business too. They refuse, 
 therefore, to allow any deficiency of earnings. In taking this 
 ground they clearly abandon the position that the sacrifice of the 
 owners is the fair value of the property. As for the capitalization 
 of a deficiency in earnings it is also urged by a few that this 
 would amount to a guarantee by the public of a fair return, 
 which they say the public can never make even though it is a 
 principal. This view, however, clearly involves a fallacy in regard 
 to the meaning of the word guarantee. To allow a capitalization 
 of a deficiency of earnings is not to guarantee a fair return. The 
 public, of course, should never guarantee a public service cor- 
 poration, which it charters, against being a losing venture; but 
 ought it not to guarantee to it rates which, if those rates will 
 produce the traffic, that is, if the traffic will bear those rates, 
 will prevent it from being a losing venture? As the price of any 
 commodity, including transportation, is raised, the demand for 
 it generally decreases. At some point the price will result in a 
 demand which will produce the maximum return. That maxi- 
 mum return may not be enough to constitute a fair return on the 
 investment. In this case the concern is a losing venture, and 
 the public cannot guarantee it, and ought not to guarantee it 
 against such contingency. But, on the other hand, if the public 
 is to regulate rates and values, ought it not to guarantee a rate 
 high enough to produce a fair return even on a value which 
 includes deficiency of earnings in previous years, if such a result 
 is possible? If this view is not taken no one will invest in a 
 public utility. If you invest in a public utility you take some 
 risk. You are willing to take the risk because your judgment 
 tells you that the concern will be a success, but would you make 
 the investment if you knew that the public was to come in later 
 and prevent your receiving even a fair return on your invest- 
 ment from the beginning though it might become capable of pro- 
 ducing large returns? These illustrations are not fanciful. 
 Street railways in many parts of the country are in a condition 
 which justifies them. In Massachusetts they have become so 
 seriously crippled that the public is not obtaining anything like 
 the service that it ought to have. The shares of one corporation, 
 in whose capitalization there is admittedly not a dollar of water, 
 
40 
 
 which has been under public regulation from the beginning and 
 some of whose stock has been issued at a price of $155 a share, 
 as fixed by the state regulating body at the time, has been 
 recently selling for under $30. 
 
 The theory of cost of reproduction as a basis of value has 
 also its defects and opponents. Those who oppose it are par- 
 ticularly active and caustic in their criticism. They designate it 
 by all sorts of epithets. One eminent critic of this theory and 
 advocate of the original cost theory says that the reproduction 
 cost theory is "utterly dishonest." This critic knows perfectly 
 well that the Supreme Court in at least two decisions has spoken 
 favorably of this theory. In the Knoxville case the Court said : 
 
 The cost of reproduction is one way of ascertaining the present 
 value of a plant like that of a public utility company, but that test 
 would lead to obviously incorrect results if the cost of reproduction 
 is not diminished by the depreciation which has come from age 
 and use. 
 
 In the Minnesota rate case the Court said : 
 
 The cost of reproduction method is of service in ascertaining 
 the present value of the plant when it is reasonably applied, and 
 when the cost of reproducing the property may be ascertained with 
 a proper degree of certainty, but it does not justify the acceptance 
 of results which depend upon mere conjecture. 
 
 Moreover, the same court in a later case, that of the Des 
 Moines Gas Co. (238 U. S. 153), distinctly upheld the cost of 
 reproduction method, saying, in approval of what had been done : 
 
 After valuing the real estate and various items of personal 
 property, as hereinafter stated, the master adopted as the only 
 practical way, in his judgment, of determining the reasonable value 
 of the buildings, their contents, yard structures, and the mains, 
 house and street lamp service, and meters, the test of estimating 
 the cost of reproducing them new and then estimating the deprecia- 
 tion which should be deducted in order to obtain their present value. 
 
 Notwithstanding these decisions of our highest court this critic 
 says the theory is "utterly dishonest." 
 
 Those who oppose the cost of reproduction method sometimes 
 intimate that it is only used by those who desire to arrive at a 
 high valuation. Thus, the same critic said, in an official decision, 
 "The reproduction cost theory has during recent years become a 
 fashionable one among many attorneys and managers of public 
 service corporations." He perhaps forgets that in the leading 
 case of Smyth vs. Ames, counsel for the railroad maintained that 
 
41 
 
 the original investment should be the basis. It appears that, 
 when the roads were built, wages were above normal, prices high, 
 and gold at a heavy premium, and that when the action was 
 brought prices had materially declined, so that it was estimated 
 that the roads could then be reproduced for less than the original 
 cost. On the other hand, counsel for the state then maintained 
 that "the present value, as measured by the cost of reproduc- 
 tion ' ' was the proper basis. Hence the critic might equally well 
 have said that the original cost theory had during recent years 
 become a fashionable one among many attorneys for and members 
 of public commissions. The value of the theory is to be judged 
 not by the persons who hold it, but by its own merits and the 
 decisions of the highest courts, which we should always respect 
 though we may personally disagree with them. 
 
 Those who uphold the cost of reproduction theory, so far as 
 I have read their views, appear to be more reasonable and mod- 
 erate in their expressions. They respect the opinions of the 
 Supreme Court and neither term them utterly dishonest nor say 
 that the Court must be forced to reverse itself. Most of them 
 appear to believe, as the Supreme Court does, that neither repro- 
 duction cost nor original cost is alone the criterion, though they 
 believe that cost of reproduction, properly ascertained, is much 
 nearer to fair present value than original cost, while some of the 
 writers who support the original cost theory apparently maintain 
 that it and they alone are infallible. The advocates of the repro- 
 duction cost theory urge, certainly not without reason, that if, 
 as the Supreme Court has said, it is the fair present value of the 
 property which is to be the basis, then let us suppose the follow- 
 ing case: 
 
 Suppose a railroad passes through a town. It has its right of 
 way, its bridges, its embankments. The problem is to find the 
 present value. Suppose it should build a branch from its station 
 in that town, diverting from its main line. It would have to buy 
 property, build bridges and embankments. On the original cost 
 theory, which no doubt here applies, the cost of its right of way 
 would be its value. They ask then, is the present value of the 
 right of way of the main line, only one hundred feet away, built 
 fifty years ago, which goes through precisely similar property, 
 any less than the value of the branch right of way just built 
 
42 
 
 simply because it was built earlier? Extend the illustration. 
 Suppose that the railroad company needs to enlarge its yard and 
 must widen its right of way or take a block adjoining one which 
 it already possesses. It takes that property, enlarges its yard, 
 builds its embankments and bridges if necessary. The cost of 
 that new property is its value at the time. Is the value of the 
 other block previously existing any less? It is in exactly the 
 same locality and under similar conditions. .Why, they say, 
 should there be a difference in the present value ? 
 
 Those who advocate the original cost method are seriously 
 disturbed by the fear that the use of the cost of reproduction 
 method will lead to rapidly increasing values and rates. Thus 
 Commissioner Lane, in the Western Advance Rate case, referring 
 to the contention of the Burlington Road that it was entitled to 
 a return on unearned increment in land value, said : 
 
 If this is a precise expression of what our courts will hold to 
 be the law, then, as we are told, there is certainly the danger that 
 we may never expect railroad rates to be lower than they are at 
 present. On the contrary there is the unwelcome promise made in 
 this case that they will continuously advance. 
 
 and he adds: 
 
 In the face of such an economic philosophy, 4 if stable and equit- 
 able rates are to be maintained the suggestion has been made that 
 it would be wise for the Government to protect its people by taking 
 to itself these properties at present value rather than to await the 
 day, perhaps twenty or thirty years hence when they will have 
 multiplied in value ten or twenty fold. 
 
 In the case of Buffalo Gas Co. vs. City of Buffalo (N. Y. Public 
 Service Commission, 2nd District, Vol. 3, 633), the Commission 
 said : 
 
 A valuation made in the case of this company in 1907 would 
 produce vastly different results from a valuation made in 1912, 
 owintr to the different prices of pipe, and yet there can scarcely be 
 any disagreement upon the proposition that the price of gas in 1907 
 and 1912 should be substantially the same. A condition of things 
 which permits the public to appeal to this Commission to fix the 
 rate in times of financial distress when materials are low and labor 
 is cheap and thereby obtain a low rate which shall obtain perman- 
 ently or substantially so; and on the other hand which permits the 
 company to appeal to the Commission to fix a rate at a time when 
 labor is high and materials are dear, and thereby fix a higher rate 
 to continue with a substantial permanency, is intolerable. If the 
 Commission were to fix the price of iron pipe upon the prices now 
 prevailing, next .year they may be 50 degrees higher. Justice would 
 require that the rate go up if the cost of reproduction now is to 
 prevail; while, on.the other hand, if pipe gets lower the rates should 
 be lower. This would require a constant juggling with prices in 
 order to carry out what would be deemed substantial justice. 
 
43 
 
 To these criticisms of the method the following reply may be 
 made. 
 
 In the first place, Secretary Lane's suggestion, that railroad 
 values may be multiplied ten or twentyfold, is an exaggeration. 
 His fear seems to have reference mainly to the increase of land 
 values, since values of the other elements may be expected to 
 fluctuate up and down, generally speaking ; but the value of land 
 in a railroad valuation is, on the average, only from about 15 per 
 cent to 25 per cent of the total value, so that if land values 
 should be multiplied ten times, which is very excessive, with other 
 values unchanged on the average the total value of the property 
 would be increased only about three times instead of "ten or 
 twentyfold." 
 
 Secretary Lane seems to think that railroad rates should be 
 expected to be lower in future than at present, and the New York 
 Public Service Commission seem to think that the price of gas 
 should remain substantially the same. The price of money, of 
 labor, of every material thing, varies from year to year, and it 
 may be pertinent to ask why it should be assumed that the price 
 of transportation or of gas should remain the same or should fall. 
 It is, of course, desirable that rates should remain stable, and, 
 if public service companies are allowed to earn a fair surplus to 
 provide for fluctuations from year to year, they will remain 
 fairly stable, as compared with the prices of materials or money. 
 The price of a thing changes either because of conditions affect- 
 ing it, which change its value, including among these supply and 
 demand, or because of a general change in the value of a dollar. 
 If, by reason of an excess of currency, the value of the dollar 
 decreases, that is to say, if it takes more dollars to buy a given 
 thing, why should transportation or gas, which are commodities, 
 be exempt from the general change in price? 
 
 Further, with reference to Secretary Lane's suggestion, it is 
 very doubtful in the minds of a great many people if protecting 
 the people means limiting the taxes and other charges imposed 
 upon them, whether the taking possession of the properties by 
 the government will protect the people. The experience with 
 government ownership does not show that it leads to decreased 
 charges, although it may be possible to hide those charges in the 
 general tax levy so that the average man may lose sight of them. 
 
44 
 
 Certainly many intelligent and unprejudiced men believe that a 
 great disillusioning will come upon the American people if they 
 resort to government ownership in the hope of reducing charges. 
 Further, with reference to the statement of the New York 
 Public Service Commission, it may be said that those who believe 
 in the cost of reproduction method do not as a rule look upon a 
 valuation as a thing to be made from year to year or whenever 
 demanded by the public or the corporation. With the increase 
 of public control, assuming the desirability of ascertaining the 
 physical value of public utility properties or the necessity of 
 doing so in some cases, these people maintain that such values 
 should be ascertained once for all simply as a starting point. 
 They believe that the past should be wiped out, and a new start 
 made, that any past errors on the part of the companies in the 
 wa}' of financial mismanagement or overcapitalization, and any 
 mistakes on the part of the public in allowing such things to 
 happen, or in allowing rates which are too high, or rates which 
 were so low as to result in financial embarrassment or bank- 
 ruptcy, should equally be forgotten, but that a new start should 
 now be made with a valuation of the physical property at the 
 present time, and that hereafter such methods of accounting and 
 such rules controlling the issue of securities and the application 
 of the proceeds should be adopted as will insure that the value 
 of the physical property at a future time can be ascertained on 
 the basis of the present value and the operating results since it 
 was made. This was even the view of Director Prouty, who, as 
 a member of the Interstate Commerce Commission, in an address 
 before the National Association of Manufacturers in New York 
 in 1907 said: 
 
 The popular impression that if the value of our railroads were 
 known it would be easy for us to adjust rates that a fair return 
 upon that value and only a fair return would be obtained, is entirely 
 erroneous. The most that can be done in most cases in fixing the 
 value of our railroads would be to determine the cost of their 
 reproduction at the present time. . . . Such a valuation would . . . 
 establish, as it were, a point of departure today from which future 
 values might in some measure be reckoned. 
 
 Commissioner Prouty evidently at that time believed that the 
 only thing that could be done in the case of railroads was to use 
 the cost of reproduction method, and he further evidently believed 
 
45 
 
 that once applied it would be not necessary to use it again, but 
 that it would serve as a point of departure for the future. This, 
 I think, is the view taken by most advocates of the cost of 
 reproduction method. 
 
 These considerations may perhaps indicate to you the com- 
 plicated character of the problem and especially the mental 
 characteristics of some of the individuals who deal with it. They 
 will perhaps substantiate the statement made at the beginning 
 of this lecture that the attitude of mind with which a subject of 
 this kind is approached is perhaps the most important element 
 in arriving at a correct conclusion. 
 
 As illustrating the lengths to which some advocates of the 
 original cost theory go, one of them maintains that overhead 
 expenses for engineering, if paid out of operating expenses after 
 the plant is put into use by members of the regular staff, are not 
 to be considered even in original cost. In other words, if a 
 company builds a temporary bridge at the beginning, puts its 
 road into operation, and subsequently replaces this bridge by an 
 expensive steel structure designed by its regular staff of engineers, 
 the engineering expense connected with this bridge is not to be 
 considered as original cost because done by the regular salaried 
 staff. In other words, this writer apparently believes that not 
 even actual original cost is to be used. 
 
 But, after all, much of this discussion is purely academic in 
 view of the fact that in many cases, as, for instance, in the case 
 of a railroad of considerable age, it is generally impossible to 
 ascertain the original cost. So far as I know, no complete esti- 
 mate of the original cost of any large railroad has yet been found, 
 or the deficiency in earnings in lean years worked out. All 
 valuations of such roads have been based on estimating the cost 
 of reproduction. This can be done with comparative ease, as it 
 involves simply making an inventory of the property and placing 
 upon each item the cost of producing it at the present time. The 
 original cost cannot be found because, in the first place, the 
 records are in many cases destroyed or inaccessible, and, in the 
 second place, because in the past accounts have not been kept 
 in such a way as to distinguish between amounts properly charge- 
 able to replacements and amounts properly chargeable to new 
 
46 
 
 construction. "When our railroads were built they were, as a 
 rule, constructed cheaply, because the money was not available 
 to construct them in any other way. As traffic grew and revenue 
 increased, a wooden trestle, for instance, would be replaced by a 
 steel bridge. The entire cost of the replacement would be charged 
 to operating expenses. The banks of a cut, originally with a 
 certain slope, would slide through the action of water, and addi- 
 tional material would have to be taken out to make the slope of 
 the banks less. This would be charged to operating expenses. 
 As a matter of fact, the latter expense is properly chargeable to 
 the original cost of producing the cut in its later condition, as 
 the excess cost of the steel bridge over the cost of replacing the 
 wooden trestle is also properly chargeable to original cost. It is 
 probably impossible to disentangle these accounts at the present 
 time in such a way as to ascertain the original cost of a large 
 railroad. 
 
 It may be urged that the accounts should have been kept in 
 such a manner as to capitalize all expenses above those necessary 
 to renew worn-out parts in the way in which they were originally 
 built. On the other hand, there is something to be said in favor 
 of the method of accounting which has been followed in this 
 country. If all renewals beyond replacements in kind are 
 charged to capital, a steady increase in capitalization and rates 
 necessarily results. In this manner the large capital of some of 
 the foreign roads has been produced. Our railroads, on the 
 contrary, have preferred to keep their capital low by taking 
 advantage of good years to make extensive replacements and 
 improvements, charging them to operating expenses. It is urged, 
 on the one hand, that since the revenue with which to pay for 
 this replacement came from operating expenses and these 
 revenues were contributed by the public in the form of rates, the 
 public has contributed to the company a portion of its capital, 
 and, therefore, that the company is not entitled at the present 
 time to any return to it by the public in rates upon such capital ; 
 but it should be remembered that the public had it in its power 
 to regulate rates and to prevent such return of capital to a con- 
 siderable extent, and that it did not do so. Further, the surplus 
 might have been distributed to stockholders. The result of this 
 development has been that this country has become possessed of 
 
47 
 
 a system of railroads unequalled by those in any other country 
 in the service that they give, and capitalized at a figure lower 
 than in any other country, and carrying their traffic at rates 
 lower, on the whole, than any other country. The history of the 
 past, therefore, has not been entirely unfavorable to the interests 
 of the public. With more stringent regulation, the history of the 
 future, many believe, will not be so favorable. 
 
 As a result of considering the controversy between the original 
 cost method and the cost of reproduction method many dis- 
 interested students have finally come to the same conclusion, 
 which is this: Neither method of ascertaining value is in all 
 cases, or perhaps in any case, the exclusive basis. Both should be 
 considered, if ascertainable. The wisdom of the decision of the 
 Supreme Court in the case of Smythe vs. Ames, so many times 
 quoted, will, I think, become more apparent the more carefully 
 this question is studied. It reads as follows : 
 
 We hold, however, that the basis of all calculations as to the 
 reasonableness of rates to be charged by a corporation maintain- 
 ing a highway under legislative sanction must be the fair value of 
 the property being used by it for the convenience of the public. 
 And in order to ascertain that value the original cost of construc- 
 tion, the amount expended in permanent improvements, the amount 
 and market value of its bonds and stocks, the present as compared 
 with the original cost of construction, the probable earning capacity 
 of the property under particular rates prescribed by statute, and 
 the sum required to meet operating expenses, are all matters for 
 consideration and are to be given weight as may be just and right 
 in each case. We do not say that there may not be other matters 
 to be regarded in estimating the value of the property. What the 
 company is entitled to ask is a fair return upon the value of that 
 which it employs for the public convenience. 
 
 Furthermore, many will thoroughly approve the words of 
 your own eminent jurist, Justice H. M. Wright, who makes the 
 following remarks with reference to the original cost method : 
 
 Original cost is urged as a criterion of value by certain econ- 
 omists and state officials. The theory is that the return in money 
 which is the inducement and the reward for serving the community 
 with water or gas, or other service, is justly to be determined on 
 the basis of the amount of sacrifice on the part of the investor, 
 and this amount of sacrifice is summarily identified with the original 
 investment in existing property. The assumption neglects to take 
 account of the fact that there would ordinarily be successive 
 owners of the property or of shares in it, and at different purchase 
 prices. Furthermore, the test proposed applies to property devoted 
 to the public use, the socialistic basis for fixing value, while the 
 property of all other persons in the community is valued in accord- 
 ance with the non-socialistic basis of our economic structure with- 
 
48 
 
 out reference to its cost. Money, the measure of value, changes in 
 purchasing power in obedience to economic laws. . . . Original cost 
 is of course a test of controlling importance in the case of newly 
 constructed or acquired property. It may be a valuable check upon 
 the value of property of moderate age; but generally it will have 
 no significance as regards property, say of forty or fifty years' 
 elapsed life. 
 
 I think that most unprejudiced students after considering 
 these matters, will be apt to agree with Judge Wright and to 
 reach substantially the following conclusions : 
 
 In the case of a public utility constructed today and under 
 public regulation from the beginning, the investor should be 
 satisfied with a fair return, commensurate with the risk involved, 
 upon the actual investment. If rates sufficiently high to produce 
 such return are guaranteed by the public the investor must take 
 the risk that the investment will be a losing proposition, and that 
 when rates are fixed so as to produce a maximum return that 
 maximum may be less than a fair return upon the investment. 
 What a fair return is will depend upon this risk, but he should 
 be guaranteed that the public will not interfere with the imposi- 
 tion of rates which, if they can be collected, will produce such 
 fair return. 
 
 In the case of utilities of comparatively recent construction, 
 and especially if under public regulation from the beginning, the 
 same basis would hold. In the case, however, of utilities which 
 have been allowed to operate for many years without public 
 regulation, a new start should now be made and a valuation fixed 
 as a starting point, accounting methods and the issue of securi- 
 ties to be subject to public approval in the future. The value 
 to be fixed as a new starting point should be, as the courts have 
 decided, not less than the fair present value of the properties and 
 in the ascertainment of such fair present value, as Judge Wright 
 so wisely says, the original cost will have no significance. Indeed, 
 neither original cost nor reproduction cost will be the sole test, 
 but we shall come back to the words of wisdom, so often quoted, 
 in the case of Smythe vs. Ames. 
 
 Another of the much discussed points regarding valuation 
 may now be referred to, as it is of great importance, namely, the 
 question whether depreciation should be deducted from the value 
 now, whether found by the original cost method or the cost of 
 reproduction method. 
 
49 
 
 When an industrial plant or a public service plant is put into 
 operation, many of the individual units immediately begin to 
 depreciate in value and condition on account of use, wear, decay, 
 and perhaps approaching obsolescence. The time will come when 
 such units will have to be replaced. How shall this be provided 
 for? At first sight it appears that the proper method would be 
 to set aside each year out of earnings, the total amount of the 
 accrued depreciation in that year, and to carry the sums so set 
 aside in a depreciation or reserve fund, paying out of this fund 
 each year for the renewals in kind which are necessary. This 
 places the company in strong financial position and enables it to 
 meet renewals when due. Such a fund, however, is a return of 
 capital to the company by those who buy its product. The same 
 result might be accomplished by building up a surplus, but in 
 this case stockholders might demand a distribution of this surplus, 
 whereas if the proper amount is held in a depreciation fund 
 stockholders may not demand that this be distributed. 
 
 Such a procedure is eminently desirable, and generally pos- 
 sible, in the case of an industrial plant, for just two reasons: 
 (1) that the industrial concern can charge any price that it 
 pleases for its product; (2) that an industrial plant frequently 
 finds itself in a position in which it is necessary to make very 
 extensive renewals in a single year. Let us consider these reasons. 
 
 1. An industrial plant is not subject, except perhaps in ex- 
 ceptional times like the present, to any public regulation. It can 
 charge what it likes for its product. It is limited only by com- 
 petition with other concerns making similar products, and it 
 generally and properly aims to make the prices which it charges 
 such as will produce a volume of sales that will result in the 
 maximum net return. Whether it makes rails or razors, or drugs, 
 or soap, or furniture, or refined oil, or any other industrial 
 product, it is not limited by the public in regard to the prices 
 which it can exact. It may earn 40, 50, or even 100 per cent of 
 its capital stock in a single year. 
 
 2. An industrial plant frequently finds it necessary to make 
 large renewals in a single year. Improvements in machinery and 
 methods of manufacture, the introduction of new apparatus and 
 processes, and other circumstances, some of them unforeseen and 
 unforeseeable, may at some time render it necessary to entirely 
 
50 
 
 reconstruct the plant in order to enable it to do business econom- 
 ically and to meet competition. When such expenditures become 
 necessary, if the company has not accumulated a surplus or a 
 depreciation fund sufficient for the purpose it may find itself in 
 a serious situation. It will either be obliged to continue its busi- 
 ness without making the renewals which are necessary and which 
 will result in economy, or it must get new capital for the purpose. 
 It is, therefore, wise for it to accumulate a depreciation fund. It 
 should make hay while the sun shines, and while it enjoys a good 
 business it should provide for the inevitable future. 
 
 Now when such a depreciation fund has been accumulated, 
 what is it ? Clearly it is original capital which has been returned 
 to the company by those who have bought its products in past 
 years. It is amortization of the capital. The balance sheet shows 
 this clearly. On the asset side stands the original cost. From this 
 is deducted the depreciation, so that the cost is carried at a 
 depreciated value. On the same side stands the depreciation 
 fund, which should be equal to the deducted depreciation. On 
 the liability side stands the original capital. When any renewal 
 of a part of the plant is necessary the situation is this: the 
 original investment in that part of the plant has not only earned 
 for its owners a fair return during its life, but the original 
 capital investment in it has also been returned to the owners by 
 the public, and is now available by the company for a renewal of 
 that element. 
 
 A public service corporation, and particularly a railroad, 
 differs radically from an industrial plant in regard to both of 
 the elements which justify the accumulation of a depreciation 
 fund. 
 
 In the first place a railroad company is not justified in asking 
 the public to return to it any portion of its original capital. It 
 is under public regulation. Its rates are subject to being fixed 
 by a public commission, and if they were not, public opinion 
 would exert a corresponding pressure. If the public, through 
 its regulating body, requires or allows the company to accumulate 
 a depreciation fund, and permits it to charge rates sufficient for 
 the purpose, it may be wise in certain particular cases for the 
 company to set aside such a fund. In electric light plants, gas 
 plants, to some extent in water works, where, as in industrial 
 
51 
 
 corporations, large renewals may become necessary in a single 
 year, it may be desirable to accumulate such a fund, and in some 
 instances the public authorities permit it, and perhaps require it. 
 A railroad, however, is essentially different. It will never 
 need renewal as a whole, or in any large part, because it consists 
 of such an immense number of separate units. It will presently 
 be shown, also, that in the case of a railroad the accumulation of 
 such a fund is neither necessary nor desirable. 
 
 What should a railroad company be allowed to obtain from 
 the public in return for the commodity which it furnishes ? ( 1 ) 
 It should be enabled to earn its operating expenses, because it has 
 to pay them out year by year, or perhaps week by week. (2) It 
 should be allowed to earn its taxes, which are paid to the public. 
 (3) It should be allowed to earn its fixed charges or the interest 
 on its fixed capital obligations, because if it does not it may be 
 obliged to go into the hands of a receiver, or to borrow money 
 to pay interest, which would be bad financial policy, and could 
 only be done at high rates if at all. (4) It must be allowed to 
 earn enough to pay for renewals as they become necessary. 
 Otherwise the property will run down and become less efficient as 
 a servant of the public. (5) It should be allowed to earn a fair 
 return to its owners on the capital stock. These then, are the 
 earnings which a railroad should be allowed to make : operating 
 expenses, taxes, fixed charges, maintenance and necessary re- 
 newals, a fair return. Should it also be allowed or required to 
 earn the amount of accrued depreciation and to carry this in a 
 depreciation fund? 
 
 A little consideration will show that this is neither necessary 
 nor desirable, for the reason that a railroad lacks the second 
 element which makes the accumulation of such a fund desirable 
 in the case of an industrial corporation. No large part or element 
 of a railroad will require renewal in any one year, because the 
 multiplicity of its parts is so great. Annually accruing deprecia- 
 tion and annual expenses for renewals tend to reach a condition 
 of equilibrium in which one of these is equal to the other. By 
 skillful management the departure from this condition of equili- 
 brium may be made very small. If a large bridge is weak and 
 needs renewal there are various methods of meeting the emerg- 
 ency. The bridge may be strengthened, or temporarily sup- 
 
52 
 
 ported by placing pile bents beneath it and shortening the span. 
 Many bridges needing renewal have been treated in this way, and 
 carried for ten or fifteen years without renewal. If a large struc- 
 ture requires renewal this year the renewal of a corresponding 
 number of smaller structures may be postponed. 
 
 To earn anything more than operating expenses, taxes, fixed 
 charges, necessary maintenance and renewals, and a fair return 
 means that the public is returning to the company its capital. 
 The company should by skilled management endeavor to make 
 renewals come due in such a way that they may be fairly uniform 
 from year to year. If in any one year a large item of expense 
 is to be met for renewals other items can be cut down or post- 
 poned by temporary measures until subsequent years. If such 
 renewals cannot be met from current earnings the company may 
 borrow money or incur a floating debt for the purpose, which 
 is retired as soon as possible even if rates have to be temporarily 
 somewhat increased in order to do so. Such a plan provides for 
 obsolescence. A new structure may be much better than the one 
 which it replaces but it seems proper that future customers should 
 bear the expense involved in securing the better facilities rather 
 than to have the expense borne by the customers who had only 
 enjoyed the benefit of the inferior facilities previously available. 
 Such a plan puts the burden of paying upon those who enjoy the 
 facilities which they pay for. 
 
 Furthermore, it is easy to see that in the case of a railroad, 
 with its great number and diversity of units, to build up a 
 depreciation fund would not only be undesirable but would 
 result in a useless fund. This is true in the case of any concern, 
 whether an industrial concern or a public service corporation, in 
 which the multiplicity of units is such that renewals in time come 
 to be an approximately constant expense. 
 
 The situation is best illustrated in the case of the ties of a 
 railroad, because ihcy are the shortest-lived element, and the 
 illustration is easier to grasp. Suppose that a railroad is 10,000 
 miles long, with 25,000 ties to the mile. It has 25,000,000 ties. 
 If these cost 60 cents apiece they are represented in the capital 
 account by $15,000,000. If the average length of life of a tie is 
 ten years, then, inasmuch as ties differ and are not all of the same 
 quality when put into the railroad and inasmuch as the wear 
 
53 
 
 upon them differs according to the location and the traffic, they 
 will, even if all are put in at the same time, wear out at different 
 times. Some of them may last only five years, others may last 
 twelve or fifteen, depending upon circumstances. Ultimately, 
 when the condition of equilibrium is reached, there would be an 
 annually accruing depreciation of ties of one-tenth of the capital 
 represented, or $1,500,000 ; and during each year about one-tenth 
 of all the ties will be renewed, at a cost of $1,500,000. The con- 
 dition of equilibrium is reached when the depreciation of the ties 
 is between 40 and 50 per cent and the depreciated value between 
 50 and 60 per cent. If a considerable portion of the railroad is 
 new the condition of equilibrium will not have been reached. Tie 
 renewals will not equal annually accruing depreciation. Assume 
 the depreciation to be 40 per cent and the depreciated value 60 
 per cent. In this case the depreciation in the ties will be 40 per 
 cent of $15,000,000 or $6,000,000, and this will be included in the 
 total depreciation of the property. During the following year 
 the annual accruing depreciation would be $1,500,000, and the tie 
 renewals somewhat less, so that the fund, if it had been set aside, 
 would be increased this year. The condition of equilibrium will 
 be reached when the fund reaches 45 per cent of $15,000,000, or 
 $6,750,000. After that time in any one year what is paid into 
 the fund would be exactly balanced by what is taken out of it. 
 The fund would represent capital for ties which has been returned 
 to the company by the public. Of what use is it to accumulate 
 this fund for the simple purpose of having it ? If the answer is 
 made, let the fund now be used to meet cost of renewals without 
 adding to the fund out of earnings, then, if this is done, the fund 
 will gradually disappear. But what would be the justification 
 for such a procedure? 
 
 At this point another consideration comes in. In an industrial 
 plant the concern not infrequently starts in with large earnings. 
 If it is economically constructed and supplies a commodity that 
 the public wants, the entire field is at once immediately opened 
 to it. Earnings may be large from the beginning. A railroad 
 company is radically different. It is generally built into new 
 country, and in advance of a market for its product, namely, 
 transportation. It builds its line into territory where the trans- 
 portation facilities have been insufficient, and where the business 
 
54 
 
 must be developed. At the beginning, therefore, its earnings may 
 be small, until the country becomes settled and its resources 
 developed. This is particularly the case with our trans-conti- 
 nental roads, like the Canadian Pacific, Canadian Northern, and 
 the American roads. In early years the earnings may be so small 
 as to produce for a long time no return to stockholders, who must 
 have faith and wait for the development of the country before 
 they get any dividend. In some instances the early returns may 
 be so small that that company cannot pay its fixed charges, and 
 is obliged to reorganize according to a plan which will cut down 
 those fixed charges. Such has been the experience of many 
 American railroads, as is well known. Now what would be the 
 use of requiring a company under such circumstances, in the 
 early days, to set aside a fund to provide for depreciation of ties, 
 thereby burdening it still further. Is it not much better to allow 
 it to develop its traffic as fast as it can, meeting necessary tie 
 renewals as they become necessary from year to year, seeing that 
 ultimately a condition of equilibrium will be reached, without 
 any fund, in which accruing depreciation will be equal to annual 
 expenses for renewals? 
 
 Every other element of a railroad is in essentially the same 
 condition that has been described with reference to ties. Bridges 
 wear out, but not all at once, as there are great numbers of them. 
 The same is true of rails, buildings, water tanks, and every other 
 element of property which depreciates. 
 
 The above seems clearly to show that the accumulation of a 
 depreciation reserve in the case of a railroad is neither necessary 
 nor desirable. As a matter of fact it is not required in the United 
 States, except in the case of equipment, and this has only been 
 required within a very few years. The Interstate Commerce 
 Commission in all the years of its existence, from 1887, did not 
 require the accumulation of a depreciation reserve, until a few 
 years ago for equipment, and many railroad men believe that 
 even this was unnecessary, because even equipment does not wear 
 out all at once. Furthermore, it may be claimed that with refer- 
 ence to other items than equipment public authorities in America 
 do not permit an accumulation of a depreciation fund for the 
 reason that although it is not prohibited, the public authorities 
 have not in general allowed rates to be high enough to permit of 
 
55 
 
 such a fund being accumulated. No American railroad accumu- 
 lates a depreciation fund, so far as I am aware, for anything 
 except equipment. 
 
 If the public authorities permit or require a depreciation 
 fund to be accumulated, and it is so accumulated and, therefore, 
 represented in the assets and in the physical valuation, then it is 
 proper to deduct depreciation from the value of the property new, 
 the amount so deducted depending upon the accounting regula- 
 tions with reference to the accumulation of the fund. Here is 
 where accounting comes in. There are various methods of esti- 
 mating depreciation, all based on an assumed life of the element 
 of the property to be depreciated. If the ' t straight line ' ' method 
 is used, that is to say, if the depreciation is supposed to be 
 uniform each year, and the fund is accumulated on this basis, it 
 should be so figured in the valuation. If the "sinking fund" 
 method is required, then this method should be figured in the 
 valuation. 
 
 The above consideration clearly demonstrates, it seems to me, 
 the following propositions : 
 
 1. In making a valuation of a public utility property, accrued 
 depreciation should not be deducted from the value new, unless 
 a depreciation fund has been accumulated, in which case the 
 depreciation for the elements covered by said fund, computed in 
 the same manner in which the fund has been computed, should 
 be deducted. The fund will be among the assets, and the depre- 
 ciation which it represents should properly be deducted from the 
 value new. 
 
 2. While in the case of some public utility properties, like gas 
 and electric light plants, it may be wise in the public interest to 
 permit, encourage, or even to require the company to accumulate 
 a depreciation fund, permitting it, of course, to charge rates 
 which will enable it to do so; yet in the case of a railroad, with 
 its great multiplicity of elements, the accumulation of a deprecia- 
 tion fund in general is undesirable and unnecessary in the public 
 interest, and results in a return by the public of a part of the 
 capital to the company, to constitute a useless and permanent 
 fund. 
 
 The case is different where there is overdue or deferred de- 
 preciation; that is to say, where renewals which were necessary 
 
56 
 
 to maintain the property in good operating conditions have not 
 been made. The company when it accepts its franchise, accepts 
 the obligation to maintain the property in serviceable working 
 condition. It must do this out of earnings, without increase of 
 capital unless improvements are made. If it neglects to make 
 necessary renewals in kind, excessive or overdue depreciation 
 results, and this it is proper to deduct from the value new in 
 order to find the present value, but only this. This represents 
 what a purchaser would have to pay if he were buying the prop- 
 erty, in addition to w r hat he pays for the property to the previous 
 owners, in order to put it into good workable condition; and he 
 should, therefore, pay that much less than what would be its 
 present value if in good workable condition. 
 
 If a railroad is properly maintained, with no overdue depre- 
 ciation, it is just as valuable an operating concern as if it were 
 new. The owner is under obligation to replace worn out parts 
 in kind when they become worn out, without increase of the 
 capital. Furthermore, the railroad as a whole never wears out if 
 properly maintained. Its life is indefinite. If the accrued depre- 
 ciation for individual items is added together it results in an 
 accrued depreciation for the entire property. We have, therefore, 
 let us say, ties on the average one-half worn out, because one- 
 half of their life has elapsed, showing a present value of 50 per 
 cent of the value known, and similarly for other elements. We 
 have, then, the entire property showing a depreciation of perhaps 
 15 per cent. All of these depreciations for individual elements 
 are worked out by one method or another from life tables, that 
 is to say, from tables based on the assumed life of the various 
 elements; and by adding these together the result is a deprecia- 
 tion in the value of the entire property as a whole. How can 
 there be a depreciation based on the life of a property and the 
 portion of it which has elapsed, if it has no determinable life, 
 that is, if its life is indefinite? The property as a whole, if 
 properly maintained, does not depreciate. A tie on a railroad may 
 depreciate, but the ties of a railroad, if property maintained, 
 never depreciate. A tie has a life of ten years, therefore if it is 
 five years old it has depreciated 50 per cent. The ties of a rail- 
 road, if properly maintained, have an indefinite life. Based on 
 this, therefore, they have no depreciation if five years of their life 
 
57 
 
 has elapsed. The property which is valued is a railroad, not a 
 part of a railroad. 
 
 Furthermore, it is clear that no depreciation should be de- 
 ducted from the value new of a properly maintained railroad 
 property when it is considered how that property in its depre- 
 ciated condition could be reproduced. The only way to repro- 
 duce it would be to reproduce it new, operate it, and get it into 
 its present condition, in which case the cost of this process w 7 ould 
 be the cost of reproducing it new. It could not be reproduced 
 with depreciated materials. If the value of a property is the cost 
 of reproducing it in its present condition, then the value of a 
 railroad property properly maintained is the cost of reproducing 
 it new. 
 
 The company is always subjected to the obligation of making 
 replacements in kind out of earnings as they become necessary. 
 If it cannot do this and is a distinctly losing venture then 
 reorganization may be necessary, with reduction of its capital and 
 fixed charges ; but so long as it has the credit to borrow money 
 to make necessary renewals w^hen they become due it should be 
 allowed to do so, since it will have to pay the interest on this 
 borrowed money as well as to make the renewals. 
 
 I believe that opinion is beginning to change with reference 
 to the propriety and fairness of deducting depreciation from 
 value new. Members of the Massachusetts Railroad Commission 
 severely criticized several years ago a report which the writer 
 made in which he advocated making no such deduction, and it is, 
 therefore, all the more interesting to find that the chairman of 
 that Commission has recently made the following statement : 
 
 In the matter of depreciation, so far as it has been a matter of 
 discussion by the Public Service Commission of this State, in the 
 various decisions which it has rendered, it has come before us in a 
 double aspect. The problem which confronted the Commission in 
 the first instance was to determine just what recognition should be 
 given to accrued depreciation, in determining the fair value of the 
 property upon which the company is entitled, under the law, to a 
 fair return. The Commission was faced with that problem shortly 
 after its organization, in the Middlesex and Boston rate case. The 
 Commission in that case began, for the first time in this State, to 
 exercise supervisory rate-making powers. It was natural, therefore, 
 that it should examine the precedents in Commission and court 
 decisions, throughout the rest of the country, in determining the 
 basis which it should use in determining fair value for rate-making 
 purposes. 
 
58 
 
 Depreciating Investment 
 
 We found that throughout the country at large, the theory which 
 had received recognition, far and away beyond any other theory; 
 that had almost become crystallized into a legal rule, was the rule 
 that a return should be allowed only upon the value of the property, 
 less depreciation. That is to say, if you had a property with a 
 value new of $30,000,000 and if it was in the normal service con- 
 dition of 75 per cent, the company would be entitled to a return on 
 only seven millions and a half, although it might have ten millions 
 of securities outstanding, which were issued under public super- 
 vision in this State. 
 
 The Commission did not believe that rule was sound or just to 
 the men who had put their money into the properties. It did not 
 believe, further, from an examination of the public utility field, 
 that the application of any theory of that kind could be enforced 
 without risking the practical bankruptcy of a large number of the 
 street railway companies in this State. 
 
 The consequence was that the Commission adopted the theory 
 that if this money was honestly invested in the properties in the 
 first instance, and that they were maintained with anything like a 
 decent degree of maintenance, that the companies and the investors 
 were not to be penalized, in the absence of mismanagement, for any 
 depreciation of the property that had been brought about in the 
 public service, unless it could be shown that the company had 
 profited from that situation, rather than the car-riding public. 
 
 The study of this subject, like the study of most subjects that 
 are largely of an economic character, is interesting as a study 
 of human nature. It discloses to us some of the virtues and many 
 of the weaknesses and prejudices of humanity. If we are, our- 
 selves, unprejudiced and open to conviction it perhaps makes us 
 more tolerant and charitable toward those who differ from us in 
 opinion, but it must convince us of the truth of the striking 
 statement of Lecky, who says in one place : 
 
 Strange veins of insanity and capacities for enthusiastic folly 
 sometimes flaw the strongest brains, and the impetuous ebullitions 
 of youth which impel some men in extravagances of vice" impel 
 other natures into equally wild extravagances of thought. 
 
 and in another place : 
 
 There is such a thing as an honest man with a dishonest mind. 
 There are men who are wholly incapable of deliberate willful un- 
 truthfulnes, but who have the habit of quibbling with their con- 
 victions and by skillful casuistry persuading themselves that what 
 they wish is right. 
 
 At all events it should make us more careful and moderate 
 in forming our own opinions and more tolerant of differences of 
 opinion, if coming from men whom we personally respect, whose 
 motives we do not question, and who express their criticisms and 
 differences with courtesy and kindness rather than with malignity. 
 
59 
 
 Finally, it seems to the speaker that there is one portion of 
 the decision of the Supreme Court in the Knoxville case which 
 has not been quoted or regarded so extensively as it deserves to 
 be. It indirectly recognizes the fact that the property of the 
 public service corporation is private property. It reads as follows : 
 
 Our social system rests largely upon the sanctity of private 
 property, and that State or community which seeks to invade it 
 will soon discover the error in the disaster which follows. The 
 slight gain to the consumer, which he would obtain from a reduc- 
 tion in the rates charged by public service corporations, is as 
 nothing compared with his share in the ruin which would be brought 
 about by denying to private property its just reward, thus un- 
 settling values and destroying confidence. 
 
Manufactured by 
 MTLORD BROS. Inc. 
 Syracuse, N. Y. 
 Stockton, Calif. 
 
 of the University of 
 TSIS7 
 
 OPT 10 
 
 192i 
 
 IMAR is if' c 
 
 I 
 
 |PT 
 
 L 19 
 
 DDL 151! 
 
 TA 
 
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