Tuesday, December 27, 2011

A Tale of Two Railroads

The history of American railroads often highlights the first transcontinental system - the joining of the Union Pacific and the Central Pacific in 1869 in Utah. This achievement was marred by the corruption and waste brought into the enterprise by the government. Subsidies, grants, and loans - even if well intended - distorted market forces and offered temptation to those inclined toward bribery and dishonesty. Sadly, the line was so poorly built - federal incentives encouraged quick building, but not careful building - that sections of it were immediately closed and had to be re-assembled. Because of these, and other, outrageous costs, the line went bankrupt.

Learning from these mistakes, James J. Hill decided to build another transcontinental network, the Great Northern Railroad. He refused to take any federal subsidies, loans, or grants, and in so doing, ensured a well-constructed railroad which would be financially sustainable and relatively free from corruption. Hill had been born into a family that was not wealthy, and he understood the business principles of working one's way up from the bottom. Historian Thomas Woods describes Hill's enterprise:

Many people have supposed that the railroads could never have been built without government largesse. But this is untrue. For one thing, the entire English railway system was built with private funds. Second, the history of the Great Northern Railroad provides an outstanding example of a businessman who prospered without any government help: railroad magnate James J. Hill.
Government help is not what it seems: it is not help. The government's attempt to "help" the first transcontinental system actually destroyed it. Even when the government has the best of intentions, its intervention into productive activity contaminates it with non-market forces. Sometimes, too, the government doesn't have the best of intentions, when corrupt individuals inside the government can personally profit from government spending schemes. James J. Hill understood this:
Hill was the entrepreneurial genius behind the Great Northern, which stretched from St. Paul to Seattle - the same market in which Henry Villard, equipped with the help of the federal government, would fail with his Northern Pacific Railroad. Hill, who came from a very modest background, eventually joined a group of friends in purchasing the bankrupt line.
Villard's Northern Pacific Railroad was another example of how to do everything wrong: he accepted subsidies, loans, and grants from the government. The line quickly went bankrupt. Because of the financial distortions it caused, it brought other businesses down with it. This is a type of ripple effect when non-market forces are introduced into the economy. Cengage's history textbook explains:
Jay Cooke's banking firm, fresh from its triumphant marketing of Union war bonds, took over the Northern Pacific in 1869. Cooke pyramided every conceivable kind of equity and loan financing to raise money to begin laying rails west from Duluth, Minnesota. Other investment firms did the same as a fever of speculative financing gripped the country. In September 1873, the pyramid of paper collapsed. Cooke's firm was the first to go bankrupt. Like dominoes, thousands of banks and businesses also collapsed. Unemployment rose to 14 percent, and hard times set in.
Under the leadership of Jay Cooke, the Northern Pacific not only was contaminated by intervention from the U.S. government, but its market dynamics were also distorted by the Canadian government. (The only thing worse than one government trying to help is two governments trying to help you.) After the Great Northern Railroad when bankrupt under Cooke's leadership in 1873, is was purchased and resuscitated by Henry Villard, who sadly repeated Cooke's mistakes, seeking help from the government in the form of subsidies, loans, and grants. Villard took the company into bankruptcy again in 1893. Finally, James J. Hill led a group of investors who bought the company and ran it successfully by avoiding any help from the government. Thomas Woods tells us that
Hill prospered. When most of the transcontinentals went bankrupt in the economic downturn of 1893, Hill both reduced his rates and turned a sizable profit. He went on to build steamships to carry American products to markets in Asia. It was a tremendous success at first, until it ran into the stupidity and destructiveness of the Hepburn Act of 1906, which regulated rail rates and gave teeth to the Interstate Commerce Commission.
Hill's strategy was so successful that he caused large exports to Asia, creating momentum for the American economy. Finally, Congress intervened, giving regulatory power to the Interstate Commerce Commission, which successfully supported the Asian economies, causing large imports from Asia. Market regulation had the power to weaken the American economy and create a trade imbalance - our reliance on imports from Asia - a problem we still have.

Monday, December 26, 2011

Railroads Get Derailed?

The creation of a transcontinental railroad system in the mid-1800's was a major engineering feat. It would also change the nation, drawing remote sections into closer contact - both commercially and culturally - with each other. The construction of this network was costly, and where much money is, much politics will soon follow. Historian Thomas Woods writes:
The transcontinental railroads in the latter half of the nineteenth century were typically built with substantial infusions of federal, state, and local government aid. This aid took two forms: loans and grants. The railroads sold the land to settlers for cash. In the process, they also created a market for their services. Those who lived near their railroad now had livelihoods that hinged on the railroad's success, usually because they needed it to ship their freight.
Although the intention was good, the government's intervention into the funding of the construction had unintended - and unfortunate - consequences. Government subsidies invariably distort normal market forces. For example, instead of connecting the various towns along the way in a straight line (the shortest distance between two points), construction companies paid by the mile could receive more money by building zig-zag or curving routes. Cengage's history textbook notes that
the Pacific Railroad Act granted land and loans to railroad companies to spur building a transcontinental railroad from Omaha to Sacramento. Under these laws, the U.S. government ultimately granted
huge amounts of land, and dollars paid by hard-working honest tax-paying citizens. Starting in 1862, millions of acres, and lots of money, was handed out - sometimes in return for bribes, sometimes as a response to political pressure, and usually with little rhyme or reason. But
Despite waste, corruption, and exploitation
Something good ultimately, unwittingly, and unintentionally came of the federal fiasco: despite the fact that this money produced largely no direct results - the federally subsidized railroads performed worse than the others, and often went bankrupt - large amounts of land and cash were transfered out of the hands of the government (where these assets produced nothing useful) and into the hands of ordinary citizens for private ownership (where the land could be agriculturally useful, and where assets generally benefit communities).

In the end, the nation's successful transcontinental railroads were either those built and financed with no government intervention and funding, or they were those which, built with government subsidies, had gone bankrupt, and were "turned around" after private owners rescued them from bankruptcy court.

Sunday, December 11, 2011

The Worst Attack?

What was the worst attack on America? There are many potential answers to this question: the British treatment of Boston during the American Revolution; the Japanese attack on Pearl Harbor; terrorist attacks on September 11, 2001. Part of answering the question would be defining the word 'worst'.

Perhaps the most devastating attack on the United States was the ratification of the sixteenth amendment in 1913. The allowed the government, for the first time in the nation's history, to levy income taxes. After 137 years, the government was now able to directly confiscate earnings of ordinary citizens.

Naturally, in order to be politically viable, the amendment had been introduced as something which wouldn't be used much or often, and which would only apply to a selected few of the "ultra-wealthy": as a Yale alumnus noted:

The tax code that started in 1913 as fourteen pages now exceeds sixty-seven thousand. An income tax that was promised to only apply to the wealthiest 1 percent in 1913 quickly grew to 5% in 1939 and then, following World War II, to almost 75% of all Americans. To soften the tax blow, the government did what it always does: it reframed the argument. When "War on Terror" was considered to be too aggressive it was changed to "overseas contingency operations," which is supposed to sound much friendlier. The same idea applied to our tax agency. The "Bureau of Internal Revenue" was renamed the "Internal Revenue Service" to, as the government puts it, "stress the service aspect of its work."
In a little over a century, the nation had left the vision of John Locke, who wrote that the government's responsibility to protect the property rights of citizens was second only to the government's task of protecting the lives of its citizens, and the nation had been subjected to a government which believed that its main mission was to confiscate the property of citizens and use it, not according to the will of the citizens, but the will of the government.