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Sunday, May 28, 2006

DanB at 9:57 PM [url]:

Learning from the history of railroads in the USA

I heard an interesting talk by Richard Adelstein that SATN readers might find of interest. Richard is an MIT grad and now a professor of economics at Wesleyan University. He kindly sent me a copy of his notes and I reproduce them here with permission. (All rights reserved by him.)

He was talking about some history of transportation in the USA and the importance of the railroads. What struck me was his statement that many things we now take for granted in business organization and business law were invented for railroads and their specific needs. The early railroad people were engineers and they created what we now think of as organizations just as they built locomotives.

Why do I include this here on SATN? As we look to the new type of transportation, bits in packets on a network, there is precedence in creating new business structures, new societal structures, and new legal boundaries. We don’t have to make things the same as the railroads any more than the railroads needed to be created in the image of the guilds and craftspeople that preceded them.

I think there may be other interesting things to learn from the history of transportation (not just railroads), especially with regards to where the line should be drawn between public and private investment and ownership, and how to create the dynamic markets that have grown society by providing basic infrastructure that benefited all.

= = = =

Railroads in the Nineteenth Century

Notes by Prof. Richard Adelstein, Professor of Economics, Wesleyan University

1.) Impact of transport on US economic, political and legal institutions, from the start has been profound and lasting.

a.) At a time when corporations were distrusted and rare, and chartered by state legislatures, the first US corps were primarily created to build roads, canals, and bridges. Success of these fueled Jacksonians' drive to liberalize incorporation laws through the 1840s.

b.) The railroads were the site of controversial experiments in the 1850s in eminent domain for the benefit of private enterprises -- a preview of the Kelo problem of today.

2.) But this deep cultural impact was largely due to the railroads. They, along with the telegraph and the steamship, made the Industrial Revolution possible by opening vast new markets, which led to massive investment after Civil War in all kinds of industries to meet the anticipated new demand. More important and less appreciated is that RRs were the first American "big businesses." In 1855, Erie RR employs 4,000. By 1893, when total strength of US military was 35,000, Penn RR alone employed 110,000. The US govt took in $385M in revenues, spent $387M and had a national debt of $997M; Penn RR alone took in $135M, spent $95M (quite a profit!) and was capitalized at $842M.

3.) RRs became prototypes of all the huge manufacturing enterprises to follow, and shaped the development of the American political economy in three defining aspects:

a.) The costs of building the RRs were immense and required finance on an unprecedented scale. Between 1815-1860, $188M spent on canals across US, largely financed by state and local governments. But by 1859, $1.1 billion had been invested in RRs, $700M after 1850. Much early investment undertaken by governments, but after 1840, burden shifted to private investors, which led to the rapid development of the NYSE to organize trade in RR securities and the development of modern investment banking, including J.P. Morgan's firm, to sell their bonds. When new industries needed capital, institutions were in place to supply it.

b.) RRs were extremely complicated organizational enterprises, requiring detailed and precise coordination of scheduling, connections with other lines, maintenance, supervision of thousands of employees and transactions, and careful planning of long and short range capital needs. No useful management models outside the military were available for this -- RRs had to invent modern management. This was done by engineers, and their techniques, built on a distinctive vision of the firm as a machine that could be controlled scientifically, had a profound influence on the governance of American firms that is just as strong today as it was a hundred years ago. J. Edgar Thompson of the Penn RR as the mentor to young Andrew Carnegie, whose first major steel plant was named the J. Edgar Thompson Works.

c.) Finally, the RRs were the first true mass production industry, and set the pattern of organization for all of American manufacturing in the half century after the Civil War. Very high fixed costs coupled with very low marginal costs implied a need for huge levels of "throughput" if the venture was to make money at all -- "The condition of cheap manufacture is running full." Low MC fuels brutal rate wars in 1870s, and some form of cooperaton was necessary if there were to be RRs at all. RR managers had experience cooperating on schedules and connections, and this led at first to "alliances" to control rates and apportion routes, then to tighter cartels, which failed for the usual reasons. Finally, in the 1880s, industry leaders consolidate into huge companies ("system building"), producing giant firms like the Penn RR. Financial maneuvering to accomplish this wasn't pretty (cf. Jay Gould and Jim Fisk), and in the end very large companies exercised very great market power over shippers in particular.

States experiment with regulating rates, which was upheld by the USSC in the 1877 Granger cases (cf. Cronon on grain elevators) because RRs were an "industry clothed in the public interest." RRs fought strenuously, and seemed to win in 1886 when SC declared RR regulation "interstate commerce" and not within the power of the states. Congress's creation of ICC makes this a Pyrrhic victory -- RRs escape frying pan of state regulation but land in the fire of federal regulation. This provides a precedent for the Sherman Act of 1890, first successfully applied to the Trans-Missouri Freight Association in 1897, which stretched the hand of federal regulation over all of interstate commerce, where it has remained ever since.

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