today.18 In most of the cases before the court the appraisal was in fact made on the reproduction theory, and the court has not expressed disapproval of the theory, but has confined its discussion to individual disputed items. In a recent case a majority of the court expressly approved "the propriety of estimating complainant's property on the basis of present market values as to land, and reproduction cost, less depreciation, as to structures." 19 There are some decisions and dicta inconsistent with this view. The court has held that where gas mains were originally laid in unpaved streets, and a few years later pavements were laid at the city's expense, the hypothetical expense of ripping up and relaying these mains was not an item to be included in the value of the mains, although clearly it would be an element in the cost of reproducing the plant.20 As to land the court has expressly rejected the reproduction (or rather reacquisition) test, since it involved addition of speculative increments based on the probable excessive cost of acquiring land for public utility purposes.21 Instead, it takes the market value of adjoining property. But with these modifications the court has on the whole stood by the reproduction less depreciation test. A closer examination, however, reveals many theoretical difficulties, on which Supreme Court decisions throw but little light. A railroad was built fifty years ago into the wilderness. Its terminals were small settlements, and a few scattered homesteads lay along its path. Now the country is thickly populated, and the small settlements have become cities with thousands of inhabitants. The problem is to ascertain what it would cost to build the railroad through this populated territory today. What conditions shall the engineer who makes the estimate assume? He must, of course, assume present costs of materials and labor. Shall he assume present physical and economic conditions of the territory through which the road is to be built? When the original road was built, the right of way ran through virgin forests. Now there is cleared and level farming land. Shall the present cost of cutting and grubbing a hypothetical strip of virgin forest be included in the valua 18 Willcox v. Consol. Gas Co., 212 U. S. 19 (1909); Minnesota Rate Cases, 230 U. S. 352 (1913). 19 Denver v. Denver Union Water Co., 246 U. S. 178, 191 (1918). 20 Des Moines Gas Co. v. Des Moines, 238 U. S. 153 (1915). 2 Minnesota Rate Cases, 230 N. S. 352, 452 (1913). tion? Today the road runs through the heart of a city, with sky-scrapers, parks and valuable residences on either side. To reproduce the railroad we must first wipe it out of existence. Can we assume that the right of way is a bare strip of land? Must we not assume that it also is covered with hypothetical skyscrapers, parks and residences, and that the cost of reproducing the road includes the cost of tearing down the buildings, however valuable, and paying compensation to the owners? Fifty years ago there were large stretches of swamp land, and it was necessary to carry on extensive engineering operations to make a solid foundation for the roadbed. Today the land has been drained by the government. Must we reconstruct a hypothetical swamp? When the road was built men, materials and supplies were hauled many miles in ox teams. Today they could be delivered in car-load lots on freight trains. Is it the present cost of ox teaming or the present cost of rail transportation that is to govern? One reservation we can perhaps make. The railroad itself, which we are valuing, we must assume to be non-existent. Even if we can assume that other railroads are available to carry rails and cross ties and labor to the scene of construction, we cannot assume that the road we are reproducing is available. But how far can we drive the consequences of such a hypothetical elimination? In estimating the market value of the surrounding real estate are we to assume that the railroad is not in existence? Millions of dollars' worth of factory sites would be wiped out on such an assumption. Whole cities may have grown up merely because the railroad developed their commerce and industry, and whole suburban regions because the railroad made them available for commuters. Shall we assume that these cities and suburban districts are still present and flourishing, or must they, also, be hypothetically wiped out, and the value of the railroad land reduced accordingly? A solution of these perplexing problems is impossible so long as we have before us the bare phrase, "cost of reproduction less depreciation." No mere grammatical interpretation of its content will help us, for the content is not sufficiently rich to contain the solution. We must go back of the phrase and look for the underlying considerations of policy out of which it has grown. But such an inquiry only presents further difficulties. Why should a railroad have a constitutional claim to a fair return on the present cost of reproducing it? It has been suggested that there is an ethical principle by which the public is entitled at all times to the service at the present cost of producing that service. In a competitive business that is, very roughly, the measure of remuneration. In a business in which competitors are kept out, the same measure should be applied. This would lead, however, to a test based not on the present cost of reproducing that particular physical property, but on the cost of reproducing a plant capable of rendering equivalent service. That is not the test generally applied.22 Moreover, it would require a theory of reproduction cost new, not of reproduction cost less depreciation. A hypothetical competitor must build a new plant. He cannot buy one second hand. The Supreme Court, however, has decided that depreciation must be deducted from the cost of reproduction new. 23 But waiving these discrepancies, is there anything logically compelling about the theory? Have we any right to assume that the community is willing at all times to pay for a service at its present cost of reproduction? Would a railroad be built at all, today, into the heart of New York City if skyscrapers and residences had to be razed to build it? Would we not perhaps content ourselves with a passenger terminal in the outskirts, easily reached by subway or elevated lines? Railroads are not generally built through full-grown cities. They are built while the city is young, while construction is cheap, and as population increases the railroad and the city mutually adapt themselves to each other along the lines of least resistance. The Supreme Court has nowhere made any articulate inquiry into the underlying considerations of theory or policy on which its doctrine of reproduction less depreciation rests. Hence we have no principle to guide us in deciding the disputed questions which I have enumerated. To hold that for purposes of construction every railroad is deemed to be in existence except the one we are valuing is purely arbitrary. It makes the final result depend entirely on the accident of ownership. If all the railroads serving a given territory are under common ownership, so that for purposes of rate-making they are valued as a whole, they must all be deemed to be non-existent for construction purposes. If they are separately owned, and are valued separately, each one in turn must 22 See Whitten, "Fair Value for Rate Purposes," 27 HARV. L. REV. 419. be deemed non-existent and all the others in operation. On the other hand, to "reproduce" all or even a substantial portion of the railroads at once, as a single national system, would involve a sudden strain on the labor and material market which would itself enormously enhance the hypothetical cost of reproduction. In short, the cost of reproduction rule, however solidly it seems at first to rest on arithmetic and engineering data, is in truth not a rule at all. It does not point to any rationally ascertainable conclusion. The conclusion depends upon which one of a great number of possible sets of hypothetical conditions we are to assume, and the rule gives us no assistance in determining which particular set we are to select. In a recently published study 24 Mr. Robert Hale has made a valiant attempt to reconcile the exchange value theory and the reproduction cost theory, and to establish the resultant on a rational basis. Mr. Hale thinks that there is such a thing as the exchange value of the physical plant, divorced from all "intangible" elements, and that this value can be ascertained without becoming enmeshed in the vicious circle of values and earnings. Mr. Hale asks us to conceive of a plant, completed and ready for operation, and in the hands of an owner who has no franchise right to operate it. He asks us to imagine further a man in possession of a franchise right to operate a public utility, but with no physical plant to operate. The price at which the owner of the plant-less franchise would buy the franchise-less plant, Mr. Hale denominates the exchange value of the physical property. Mr. Hale points out that since the owner of the franchise has the alternative of himself building a new plant, the exchange value of the plant cannot under any circumstances exceed the present cost of reproducing an equally efficient substitute (due allowance being made, of course, for depreciation). And since the owner of the franchise will not under any circumstances pay more than the capitalized prospective earning power of the business, the exchange value may be less than the cost of reproduction. The exchange value of the physical property, then, is its reproduction cost less depreciation, provided that is not more than the capitalized prospective earning power. Mr. Hale does not contend that the exchange value, so defined, 24 Valuation and Rate-Making, ch. 1. has been adopted by any court as the basis of rate-making, or even that it should be. His contention is that it could be adopted, without logical fallacy, since it provides an ascertainable quality which can be termed "value," and since it avoids the vicious circle of the market value theory. It seems to me that even this modest claim cannot be sustained. It is true that the hypothetical owner of a plant-less franchise would not pay more for a plant than the cost of building an equally efficient substitute. But the utmost figure which a purchaser will pay is not a fair criterion of exchange value. We must consider also the lowest figure which the seller will take. Obviously the owner of a franchise-less plant has no possible use for the plant himself. As a last resort he can sell it for junk, but unless he sells it, it is worth nothing to him. When a purchaser and a seller approach each other under these conditions, there is no possible method of estimating what the exchange price will be. All we can tell is that it will range somewhere between reproduction cost less depreciation, and junk value. At what point between these limits the parties will strike a bargain depends upon their relative trading ability, the intensity of their respective desires to part with or acquire the property, their ability and willingness to wait, and similar factors. Such a property has no ascertainable exchange value. Mr. Hale has simply taken the upper limit of the possible range of price, and called it exchange value. Of course it is possible to conceive of a situation in which this upper limit would be the price at which the property would change hands. There might be some other use to which the property could be put, just as lucrative as the use covered by the franchise. Or there might be several competing owners of plant-less franchises bidding for the plant. But the first supposition is almost invariably contrary to fact. The second is possible, but the possibility should not be taken into account in establishing a general constitutional rule. The number of franchises which a state may grant is entirely within its own discretion. It is entirely free to decline to grant more than one franchise to operate in a given field. If it has granted more than one franchise, it is entirely free to revoke all franchises but one, either under the reserved power in the state constitution or by eminent domain, and such revocation cannot be complained of by the owner of physical property suitable for use under the franchise, however much the market value of his physical |