By: Burton W. Folsom, Jr.
In the ongoing war of ideas in American history, those who advocate government action as an engine of economic development have been encouraged by a general and all-too-human tendency to avoid thinking deeply. Because we have the assumption – both among those who design government programs and among the constituencies that support them – has usually been that government action accomplishes its objectives. Even people who have reservations about bureaucratic inefficiency reason that we wouldn’t have turned to government so many times in the past if government hadn’t accomplished something.
This shallow conclusion dovetails with another set of assumptions: First, that the free market, with its economic uncertainty, competitive stress, and constant potential for failure, needs the steadying hand of government regulation; second, that businessmen tend to be unscrupulous, reflecting the classic cliché image of the “robber baron,” eager to seize any opportunity to steal from the public; and third, that because government can mobilize a wide array of forces across the political and business landscape, government programs therefore can move the economy more effectively than can the varied and often conflicting efforts of private enterprise. But the closer we look at public-sector economic initiatives, the more difficult it becomes to defend government as a wellspring of progress. Indeed, an honest examination of our economic history – going back long before the 20th century – reveals that, more often that not, when government programs and individual enterprise have gone head-to-head, the private sector has achieved more progress at less cost with greater benefit to consumers and the economy at large.
America’s early experience with the steamship industry provides an illustrative case. By the 1840s, the technology of steam-powered water transport had reached the point where it became practical to build large, ocean-going vessels, and steamships began plying the route between New York City and Liverpool, England. An enterprising fellow named Edward K. Collins approached the U.S. Congress with a plan to develop a steamship fleet that could compete with Britian’s Cunard Company. Since the Cunard operation was subsidized by the British government, Collins asked Congress to provide him with a grant of $3 million to underwrite construction of five vessels and a yearly supplement of $385,000 so he could run his line at the competitive fare of $200 per passenger and undercut Cunard’s rates for carrying freight and mail.
Collins was what may be called a “political entrepreneur.” Playing skillfully on congressional fears about British domination of the transatlantic trade, and promising that his ships could serve as the basis of a merchant marine fleet in the event of war, Collins got his money. He then proceeded to build four very large and luxurious ships, instead of the five smaller vessels provided for in the agreement, and he took far longer than anticipated to get his fleet into operation.
Collins ran his ships on the same schedule as Cunard, sailing every two weeks, and he often did beat Cunard’s crossing time by one day, though at considerably higher operating costs. But while he had promised Congress that his yearly subsidy could eventually be phased out, he was soon lobbying for annual increases to about $500,000, $600,000, $700,000, and then to more than $800,000 per year.
Cornelius Vanderbilt, who had made his mark as an operator of river steamboats, approached Congress with a proposal for an “Atlantic ferry,” offering to match Collins’ two-week sailing schedule at half the cost of Collins’ subsidy. Congress debated Vanderbilt’s proposal. But having made a commitment to Collins – and by now a considerable investment as well – Congress turned Vanderbilt down.
Vanderbilt was undeterred. He went into operation without a subsidy, using privately financed ships, set up a self-insurance arrangement by which he was able to save on payments to outside insurers, and ran his ships at slower speeds to save fuel. He also reduced the fare, and he invented a new, cheaper passenger class, by which people could travel below decks, in what was called steerage, for as little as $30. Vanderbilt’s “sardine class” made it possible for many immigrants to come to America.
After a year, Vanderbilt’s operation was flourishing, and Collins, in serious trouble from competition with Vanderbilt, went to Congress to ask that his subsidy be raised, yet again, to almost $900,000. Collins wined and dined key members aboard his luxurious ships and was able to convince the congressmen to conclude that since they started with Collins, it would be dishonest to take his money away now.
But Collins recognized that each time he went back to Congress for more money, the vote was closer. He decided that if he couldn’t beat Vanderbilt on price, he would concentrate on beating his crossing time, demonstrating that the Collins line clearly offered the most efficient way to get from Liverpool to New York City. This strategy had its dangers. Long beset with maintenance problems because their engines were too large for their hulls, Collins’ ships began to feel the strain of this high-speed policy. Two of the ships – half his fleet – sunk, killing almost 500 passengers, and Collins faced the humiliation of going back to Congress to beg for more money for construction of a replacement vessel and an increase in his subsidy.
Again Congress funded him. But at $1 million to build, the new ship was so poorly constructed that it had to be sold at auction after its first voyage – at a $900,000 loss. When Collins went back to Congress for still more money to build yet another ship, he was finally turned down.
It is interesting to look at the reaction in Congress after being embarrassed again and again by the subsidies to Collins. Senator Judah Benjamin of Louisiana said, “I believe [the Collins line] has been most miserably managed.” Senator Robert Hunter of Virginia went further. “The whole system was wrong,” he said. “It ought to have been left, like any other trade, to competition.” Senator John Thompson of Kentucky insisted, “Give neither this line nor any other a subsidy. Let the Collins line die. I want a tabula rasa . . . a new beginning.”
Collins had his subsidy stripped and had to compete head to head – unsupported – with Vanderbilt. Within a year, Collins went bankrupt, and Vanderbilt was the dominant force on the seas from the American side.
It would be comforting to report that the U.S. learned its lesson about federal subsidies from the Collins/Vanderbilt experience. Unfortunately, less than a decade later, would be railroad builders were coming to Congress begging for money to span the nation with transcontinental lines. Congress subsidized three transcontinental railroads: the Union Pacific, the Central Pacific, and later the Northern Pacific.
These companies, which were provided with money and land by the government, had no incentive to build their lines efficiently, along straight routes with even grades and proper materials. Eventually they went bankrupt. The Union Pacific and the Central Pacific did so only after eating up forty-four million acres of free land and $61 million in cash loans. Large sections of the lines they did complete soon had to be rebuilt and sometimes even relocated due to shoddy construction.
The privately funded Great Northern, which, by contrast, operated on a shoestring budget, was a success. Unlike his competitors, James J. Hill built the Great Northern for durability and efficiency. “What we want,” he said, “is the best possible line, shortest distance, lowest grades, and lease curvature that we can build.” That meant he personally supervised the surveying and construction. “I find that it pays to be where the money is being spent,” he noted. He believed that building a functional and durable product actually saved money. For example, he usually imported high quality Bessemer rails, even though they cost more than those made in America. He was thinking about the future, and quality building cut costs in the long run. When Hill constructed the solid granite Stone Arch bridge – 2,100 feet long, 28 feet wide, and 82 feet high across the Mississippi River – it became the Minneapolis landmark for decades. Yet today Hill is regarded as just another member among the ranks of greedy, amoral “get rich-quick” capitalists.
Even when entrepreneurs have led the way entirely, developing industries in fields where federal money had never been involved, suspicion and resentment about the motives and methods of the “robber barons” have encouraged government to thrust itself into business – often with absurd results, as the example of Andrew Carnegie and the steel industry shows.
When Carnegie founded Carnegie Steel in 1972, the biggest steel producer in the world was England and the going price of steel rails was about $60 per ton. Carnegie was an eager innovator. He adopted the revolutionary Bessemer process and introduces new accounting methods to make his operations more efficient, applied a merit pay system to reward his workers, and implemented many employee-suggested ideas. Carnegie Steel became so efficient that by 1900 the company could produce steel rails at $11 per ton, and its rail output surpassed that of all the steel mills in England combined. Other U.S. firms followed Carnegie’s lead, and America became the dominant steel producer of the world.
But the success of American steel companies and the great wealth of their owners was not regarded as a testament to the power of free enterprise. Instead it became a cause for concern. The common attitude was summed up by Senator Ben Tillman of South Carolina, who referred to the steel-makers as “greedy and hoggish.” Where there was profit, there had to be price gouging. President Woodrow Wilson became convinced that Congress should establish a government-operated steel mill to compete with the private manufacturers, and after much debate, a federal steel facility was built in Charleston, West Virginia, at a cost of $17.5 million.
It was a blessing to Wilson that he became too ill to concern himself with the results of his venture, which set about the task of producing steel armor plate. Indeed, armor plate was produced – at roughly $800 per ton! When the Republicans won the next election and Harding succeeded Wilson in the White House, the Charleston plant was quietly closed.
Time and again, experience has shown that while private enterprise, carried on in an environment of open competition, delivers the best products and services at the best price, government intervention stifles initiative, subsidizes inefficiency, and raises costs. But if we have difficulty learning from history, it is often because our true economic history is largely hidden from us. We would be hard pressed to find anything about Vanderbilt’s success or Collins’ government-backed failure in the steamship business by examining the conventional history textbooks or taking a history course at most colleges or universities. Likewise, we probably wouldn’t learn how the three subsidized railroads went bankrupt while the unsubsidized succeeded, or about the federal government’s disastrous foray into the steelmaking business. The information simply isn’t included. I should know: I received a Ph.D. in U.S. economic history, and I never encountered these stories until after I was out of graduate school.
But missing information isn’t the only problem. In some cases, the facts of American history have been so thoroughly distorted as to make economic understanding impossible. The historical treatments of one early experience with adjusting income tax rates provides a good example. Irwin Unger, in his text, These United States, describes the tax policy of U.S. Treasury Secretary Andrew Mellon, who served under three presidents, but mainly President Calvin Coolidge, between 1921 and 1932:
[Harding and Coolidge] allowed Secretary of the Treasury Andrew Mellon, a Pittsburgh industrialist and one of the world’s richest men, to pursue “soak-the-poor” policies . . . He persuaded Congress to reduce income tax rates at the upper level, while leaving those at the bottom untouched. Between 1920 and 1929, Mellon won further victories for his drive to shift the tax burden onto the backs of the middle and wage-earning classes.Similarly, in their textbook, The National Experience, Arthur Schlesinger, Jr., and John Blum note:
It was better [Mellon] argued, to place the burden of taxes on the lower-income groups, for taxing the rich inhibited their investments and thus retarded economic growth. A share of the tax-free profits of the rich, Mellon reassured the country, would ultimately trickle down to the middle- and lower-income groups in the form of salaries and wages.
This is the picture we get from two of the leading American history textbooks. But what are the actual facts of Mellon’s and Coolidge’s tax policy? In the 1920s, the tax rate on the highest income group went from 73 percent down to 24 percent – a three-fold reduction. At the same time, the tax rate on the lowest income group went down from four percent to one half of one percent – an eight-fold reduction. And in 1929, after Mellon and Coolidge had implemented their tax cutting policy, the government was collecting some 30 percent more tax revenues than had been collected with the higher tax rates of the early 1920s – an experience which would be repeated years later in the tax reductions of the Kennedy and Reagan administrations. We can speculate on ideological motives that may have prompted these historians to present to present the kind of picture they did, but the bottom line for us as citizens is that we cannot draw appropriate conclusions about the proper role of government from missing or distorted information. Only when the true facts are available can real debate begin.
Even armed with the evidence, however, what we need to realize is that competition is not painless, and progress is not easy. There are losers as well as winners in our history, and we need to understand them both without blaming either group. This means, of course, that we have to learn what capitalism is all about. In the words of philosopher Ronald Nash, “Capitalism is quite simply the most moral system and the most equitable system of economic exchange.” Why does he make this assertion? Because throughout our history, capitalism has provided the opportunity to compete – the chance for individuals with ambition to get into the game, to test their talents and abilities and ideas against those of everyone else, unrestrained by the Old World strictures of landed wealth and rigid social class. When those individuals have been able to pursue their dreams, free form the distorting influence of government interference, progress has been made and society in general has benefited enormously.
