The Langreo Railway

Case

The Langreo Railway runs from the mining area of the valley of Langreo to the seaside harbor of Gijón, both located in what was the remote Northern Spanish region of Asturias. Construction began in 1847,[1] with private money and a state guaranty of a minimum return of 6 per 100. The main promoter of the railway was the Duke of Riánsares, husband of the queen mother and at the time the owner of important mines and mining rights in the area of Langreo. The Duke was subsequently to lose control of the railway, after falling from political power.

At that time, import tariffs on coal were as high as 65.21 reales per ton, but were reduced by half in 1862. although they still accounted for 85 per 100 of the cost on board of British coal. However, in 1869, they were further reduced to 5 reales per ton (Nadal, 1975, pp. 135-6), approximately 10 per cent of the cost in Great Britain.

The railway began working in 1853 and was finally completed in 1856. When construction was almost complete, one firm was extracting three out of four tons of all the coal produced in the area served by the railway. Later, the company “Houillère et Métallurgique des Asturies”, created in 1865 and owner of the steel works “Fábrica de Mieres”, was said to have funds “for acquiring ... a block of shares of the Langreo railway and the coal mines of Sama” (pp. 171-2). The railway was extended in 1895 to reach Laviana, another mining town. This extension was undertaken as a joint venture with mining firms (Ojeda, 1985, p. 124).

From 1842 to 1856, transport costs from Sama to Gijón went down from 2.50 to 0.745 reales per quintal (a traditional unit of weight) but over the same period the price of coal at pit head increased from 1.50 to 2 reales per quintal. This increase coincided with a decline in the price of coal in Gijón as from 1849, from 4 to 3.30 reales per quintal. During its first year in 1853 the railway charged a standard price for all commodities, whether coal or iron ore. However, from 1855 iron ore and coke paid higher prices than coal, and from 1869 different prices were paid for screened coal as opposed to non-screened (menudos). The railway then charged a third more for iron ore, even though for the same weight this occupied a third less space than coal. The railway conceded a premium of Pta 3 per tm.—14.4 per 100 of the total transport fee for screened coal— to coal destined to foreign countries or locations to the south of Lisbon. There were also limitations on extraction and loading. (The capacity of Gijón harbor was insufficient at that time). The railway adapted its prices to the economic cycle. And the tariff reduction of 1869 (from 8.125 to 1.25 and later on to Pta 2.50 per tm) was accompanied by a reduction in the transport fee from Pta 5.89 to 5.21 per tm (11.59 per 100) and the concession of substantial volume discounts of up to 25 per 100 in 1869 and 35 per 100 in 1871 for coal transported in excess of 600,000 and 1,000,000 reales, respectively. Greater utilization of the railway did not seem to occur, however.

As soon as the railway was built, it faced strong opposition from its customers over its prices. A political battle was fought and, finally, the Government decreed a substantial reduction in the tariff in 1879.

Analyze the economic logic behind the main decisions in this case:

(a) the construction of the railway,

(b) the price reduction by the government, considering both short and long term effects; and

[1] Most of the data for this case provides from Ojeda (1985). It has been further analyzed in Arruñada (1993, pp. 693-697).

1. OJEDA, G., Asturias en la industrialización española, 1833-1907, Siglo XXI, Madrid, 1985.

2. ARRUÑADA, B. (1994a), “El reparto del monopolio: Obreros y empresarios en la historia de Asturias”, en J.L. García Delgado y L. Fernández de la Buelga, (comp.), Economía y empresa en Asturias: Homenaje al Marqués de Aledo, Civitas, Madrid, pp. 679-720.

Analysis

(a) It might have been a mistake, because it was based on prices that were artificially high because of tariffs. Those tariffs were reduced from 65.21 reales/tm to only 5 reales/tm in 1869; this fact may call into question, therefore, the construction of the railway.

(b) In the long term, it affected the propensity to invest because the railway ended up being expropriated (the reduction in prices should have reduced the return from investments on the railways).

(c) Hypothetically, this negative effect might have been outweighed by an efficiency gain if it allowed for greater utilization of the railway. Data shows, however, that this was already being achieved by contractual means. The Coase theorem is applicable:

If it had been profitable to send a larger amount of coal outside the region after the drop in tariffs, the reduction in transport would not have been prevented by the monopolistic control of the means of transport. This control would only have determined the appropriation of the profits by the owners of the transport and not by those of the mines but without affecting the volume carried. In addition, in this case, it must be remembered that the monopoly is bilateral. The constant political fight over prices between the railway and its customers seems to reflect a fight for the distribution of the monopolistic benefits enjoyed by the producers of Spanish coal and by those who added value to it including, obviously, the means of transporting it. If this hypothesis is valid, the conflict between the two parties would have intensified with greater protection of Spanish coal and the amounts carried would have varied more with the degree of protection of coal—in general, with demand and therefore with the value of coal—than with transport prices. Ojeda gives an indication that the reduction in the transport price in 1856 only redistributed the surplus between the miners and the railway without promoting an increase in traffic (1981, p. 220). Before supporting this argument with the empirical indications of the case, two possible objections should be refuted. The first refers to the difficulties of negotiating a satisfactory solution. In this case, the transaction costs do not seem to have been large. And when the railway line was completed, the situation was practically one of bilateral monopoly as a single company extracted three quarters of the coal from the mine served by the railway. It was reasonable for it to receive an immediate, substantial price reduction (Ojeda, 1985, p. 73). Nor are the conclusions of the analysis affected by the fact that the construction of the railway line received public funding. The optimum price has nothing to do with the source of the finance for the project. In addition, empirical evidence supports the argument:

(1) coal prices at pit head varied when the transport price changed;

(2) there were attempts at vertical integration; and

(3) the railway caused price discrimination:

(1) The first are the trends in coal prices at the pit head and in Gijón harbor which confirms the theory that variations in the price of transport only distributed the total profit between the railway and the mining companies. Between 1842 and 1856, transport costs dropped noticeably, pushing up the price of coal at the pit head even though it had dropped at Gijón harbor. This rise in the price of coal at the pit head was unlikely to be caused exogenously as this would also have risen the price of coal at the port..

(2) There are three indications of vertical integration, at least with respect to the shareholders of the companies. Firstly, the promoter of the railway owned mines in the area so many of the problems arising later between the miners and the railway might have been because he was losing control of the railway. Secondly, “Houillère et Métallurgique des Asturies” had the necessary funds and, thirdly, mining companies participated in the extension to Laviana.

(3) Finally, another solution to the problem caused by the monopolistic situation of the railway was to use a variable rate that would discriminate prices. By charging higher prices for the most valuable loads and offering discounts for the least valuable, the use of the railway line was raised. This solution was adopted promptly, as stated in the text. The possible differences in the differential cost of transporting the various goods seem to have been insufficient, especially in the case of the different types of coal, to justify the difference in the prices. These can be explained in the wish of the railway to maximize its use by price discrimination. The same can be said and with greater justification of the discounts for volume and destination. For the premium on the transport of coal to foreign countries, there is no difference whatsoever in the cost of transport since it is the same good and the only difference is in the final destination. It therefore seems that this is the typical conduct of a monopolist who, by price discrimination, manages to maximize his profits while eliminating much of the inefficiency which, in the absence of discrimination, would by caused by the monopoly, such as a poor level of production or in this case of transport. If, under such conditions, the amounts extracted were below the optimum level, this would have been due more to limitations on extraction or on loading than to the conduct of the railway. The railway was anyway aware that its profitability was linked to the survival of the mining and iron companies, as shown in the fact that it adapted its prices to the industrial situation and to the tariff reduction of 1869.

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