Lessons From American History: Governments Are Terrible Investors. Part I

In 13 History on 2012/08/31 at 11:11 AM

John Steele Gordon

John Steele Gordon
Author, An Empire of Wealth:
The Epic History of American Economic Power


Economic Lessons from American History

JOHN STEELE GORDON was educated at Millbrook School and Vanderbilt University. His articles have appeared in numerous publications, including ForbesWorthNational ReviewCommentary, the New York Times, and the Wall Street Journal. He is a contributing editor atAmerican Heritage, where he wrote the “Business of America” column for many years, and currently writes “The Long View” column forBarron’s. He is the author of several books, including Hamilton’s Blessing: The Extraordinary Life and Times of Our National DebtThe Great Game: The Emergence of Wall Street as a World Power, and An Empire of Wealth: The Epic History of American Economic Power.
The following is adapted from a lecture delivered on February 27, 2012, aboard the Crystal Symphony during a Hillsdale College cruise from Rio de Janeiro to Buenos Aires.

AMERICA is still a young country. Only 405 years separate us from our ultimate origins at Jamestown, Virginia, while France and Britain are 1,000 years old, China 3,000, and Egypt 5,000. But what a 400 years it has been in the economic history of humankind!

When the Susan ConstantDiscovery, and Godspeed dropped anchor in the James River in the spring of 1607, most human beings made their livings in agriculture and with the power of their own muscles. Life expectancy at birth was perhaps 30 years. Epidemics routinely swept through cities, carrying off old and young alike by the thousands. History tends to dwell on a small percent of the population at the top of the heap, but the vast mass of humanity lived lives that were, in the words of Thomas Hobbes, “nasty, brutish, and short.”

Today we live in a world far beyond the imagination of those who were alive in 1607. The poorest family in America today enjoys a standard of living that would have been considered opulent 400 years ago. And for most of this time it was the United States that was leading the world into the future, politically and economically.

This astonishing economic transformation provides rich lessons in examples of what to do and not do. Let me suggest five.

1. Governments Are Terrible Investors

When the Solyndra Corporation filed for bankruptcy last summer, it left the taxpayers on the hook for a loan of $535 million that the government had guaranteed. In a half-billion-dollar example of how governments often throw good money after bad, the government had even agreed to subordinate the loan as the company’s troubles worsened, putting taxpayers at the back of the line. In retrospect, it is clear that the motive behind the loan guarantee was political: to foster green energy, an obsession of the left. And that’s the problem with government investment: Politicians make political decisions, not economic ones. They’re playing with other people’s money, after all.

History is littered with government investment disasters. The Clinch River Breeder Reactor, for instance, authorized in 1971, was estimated to cost $400 million to build. The project ran through $8 billion before it was canceled, unbuilt, in 1983. A half century earlier, the Woodrow Wilson administration thought it could produce armor plate for battleships cheaper than the steel companies. The plant the government built, millions over budget when completed, could not produce armor plate for less than twice what the steel companies charged. In the end it produced one batch—later sold for scrap—and shut down.

Going back even farther, to the dawn of the industrial age, consider the Erie Railway. In order to get political support for building the Erie Canal, Governor DeWitt Clinton promised the New York counties that bordered Pennsylvania (known as the “Southern Tier”) an “avenue” of their own once the canal was completed. The canal was an enormous success, but as such it affected the state’s politics. A group of politicians from along its pathway, the so-called Canal Ring, soon dominated state government. They were not keen on helping to build what would necessarily be competition.

A canal through the mountainous terrain of the Southern Tier was impossible, and by the 1830s, railroads were the hot new transportation technology. But only with the utmost effort did Southern Tier politicians induce the Legislature to grant a charter for a railroad to run from the Hudson River to Lake Erie through their counties. And the charter almost guaranteed economic failure: It required the railroad to run wholly within New York State. As a result, it could not have its eastern terminus in New Jersey, opposite New York City, but had to end instead in the town of Piermont, 20 miles to the north. It was also forbidden to run to Buffalo, where the Erie Canal entered Lake Erie, terminating instead in Dunkirk, a town 20 miles south. Thus it would run 483 miles between two towns of no importance and through sparsely settled lands in between—not unlike the current proposed California high-speed rail project, the first segment of which would run between Fresno and Bakersfield and cost $9 billion.

The Erie Railway was initially estimated to cost $4,726,260 and to take five years to build. In fact, it would take $23.5 million and 17 years. With the depression that began in 1837, it soon became clear that only massive state aid would see the project through. So New York State agreed to put up $200,000 for every $100,000 raised through stock sales. Even that was not enough, however, and the railroad issued a blizzard of first mortgage bonds, second mortgage bonds, convertible bonds, and subordinated debentures to raise the needed money. This mountain of debt got the Erie completed in 1851, but it would haunt the railroad throughout its existence. Indeed, the Erie Railway would pass through bankruptcy no fewer than six times before it disappeared as a corporate entity in the early 1970s.

Why was the Erie Canal a huge success—it even came in under budget and ahead of schedule—that made huge profits from the very beginning, while the Erie Railway was a monumental failure? One reason was that canal technology was well-established and well-understood by the early 19th century. More important, the route of the Erie Canal was the only place a canal could be built through the Appalachian Mountains. Thus it would have no competition. And the reason the canal was built by government was that the project was simply too big for a private company to handle.

A very similar situation arose in the 1950s. Three decades before, a young U.S. Army captain had joined an expedition in which the Army had sent a large convoy of trucks from Washington to San Francisco, to learn the difficulties of doing so. They were very considerable because the nation’s road network hardly deserved the term. By the 1950s, that young captain had become president of the United States and road-building technology was well understood. Dwight Eisenhower pushed a national network of limited-access roads through Congress, and the country has hugely benefitted from the Interstate Highway System ever since.

Both the Erie Canal and the Interstate Highway System are passive carriers of commerce. Anyone can use them for a fee, although many Interstates are paid for through the Highway Trust Fund. But a railroad is a business that can only be profitable with careful attention to the bottom line forced by competition. And governments are notoriously bad at running businesses because government businesses are always monopolies. Just remember your last customer-friendly visit to the Department of Motor Vehicles.

In addition to building infrastructure such as the Erie Canal and the Interstate Highway System, government can be good at doing basic research, such as in space technology, where the costs were far beyond the reach of any private organization. Only government resources could have put men on the moon. Nevertheless, I’m encouraged to see that the next generation of rockets is being developed by private companies, not NASA. That’s a step in the right direction.

Unfortunately, we are headed the other way with the American medical industry.


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