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.