In an otherwise excellent article, John Stossel repeats a historical fallacy that is one of my pet peeves. He says:
The railroad didn’t make economic sense at the time, so the government subsidized construction and gave the companies huge quantities of the best land on the continent. [emp added]
This is one of those assertions that gets repeated endlessly until it becomes widely viewed as unquestionable fact. Indeed, it does seem self-evident because one need only look at a map of the 19th century land grants to see that the grants covered vast stretches of land that today are some of the most productive and valuable agricultural lands in the world.
There is just one problem. Most of that land today, and even more so in the late 19th century, is valuable for only one reason:
It has a railroad running though it.
There is nothing intrinsically valuable about land no matter how fertile. Land only has value if people can farm it, mine it, lumber it, build on it or pay good money just to look at it. In order to do any of those economic activities people have to (1) be able to get to the land themselves, (2) bring in supplies and tools to carry out some economic activity and (3) ship the resulting products to market at a price the customer will pay.
Prior to the railroad, any farmlands, timberlands or mineral deposits were valueless if a heavy wagon could not carry a load from the site to navigable water within a day. It’s no coincidence that even today, the most valuable real estate in the world sits around natural ports linked to inland water ways, e.g., Manhattan. Prior to railroads, this reality lead to strange economic paradoxes such as it being cheaper in 1830 to ship coal to New York from 3,000 miles away in England than to ship coal mined just a couple of hundred miles away in Appalachia.
Looking again at the land grant maps with an eye towards geography reveals that the vast majority of lands “given” away to railroads had no significant navigable waterways linking them to distant markets. For example, the largest land grant ran across modern day North Dakota, Montana and Idaho, none of which have any significant navigable waterways. Even places that look to modern eyes like they should have had water transport, e.g., Michigan or northern California, didn’t. Although Michigan is surrounded by the Great Lakes on three sides and had coast ports that rivaled those built on saltwater, the interior of Michigan was originally ruggedly wooded with no navigable waterways. Even dirt roads and farms had to be laboriously hacked through dense hard wood forest. A day’s ride inland from the Great Lakes and people found themselves in a transportation desert. On the west coast, there is not a major usable harbor between San Francisco and Portland and no navigable rivers. One of the most verdant areas of earth just sat there largely unusable before the railroad.
When the land grants were “given” to the railroads, the federal and state governments didn’t own vast tracts of “valuable” land. They owned vast tracts of worthless land. The land would only become valuable if someone built a railroad, but investors wouldn’t risk building a rail line unless it lead to valuable land that generated trade the railroads could carry at a profit.
It was a classic chicken and egg dilemma. No economically productive land, no railroad. No railroad, no economically productive land.
The land had to pay because railroads back then were tremendously expensive to build. It took the equivalent of modern billions in investment to create a useful rail line of just a hundred miles and the risk of failure was very high. In the modern world, probably only deep sea drilling rigs cost as much and pose as great a danger of failure. During the Civil War, railroads were still so expensive that most states only had one or two rail lines across the entire state. Sherman burnt Atlanta because a whopping four rail lines lead into the city making it the transportation hub of the entire Confederacy!
Because of the great expense and long payoff times, it was mathematically impossible for anyone to fund a railroad out into the unsettled boonies and make a profit. “Build it and they will come” didn’t pay for railroads. Without land grants, railroad investors would have to build the entire line out into the wilderness, then operate the line at a loss for years until the people who settled the land (only after it had a railroad) started shipping goods back to market. That could take years or decades. Covering the cost of that much capital for that long of a time would have made the necessary price for shipping the land’s eventual output far too high to make the output salable at all.
The land grants solved this problem by giving investors something they could sell at a profit as soon as the railroad finished construction. They could even sell speculators the possibility to buy the land if the government transferred ownership. Everyone knew the land would be valuable if it had a railroad, so once people saw the land could possibly have a railroad, rights to the formerly worthless land became valuable enough to be sold to fund the development of the railroad that made the land valuable.
The railroad land grants worked the same economic alchemy as the Homestead Act, transferring economically worthless land into private hands who turned it into land of great economic value. The property of the American heartland and that of America in general exist because of the positive development feedback loop the railroad land grants jump started.
It is true that there there were a lot of government abuses associated with the development of the railroads. There always are when government and land ownership collide. Most of those abuses occurred east of the Mississippi on long settled land when corrupt officials used eminent domain to steal people’s land and hand it to railroads. Usually, they did so under the same “economic development” excuse that Kelo made the law of the land today. The land grants weren’t a major part of the corruption for the simple reason that the land granted had no value without major private investment. Since no one could make money off land grants without risking a great deal of their own money, corrupt politicians shied away.
Ever since the time of the railroad land grants, people have tried to use them as an example of supposed large scale economic intervention by the state in the 19th century, or to justify big government spending or intervention today. However, the land grants differed from modern interventions and modern spending precisely in that they cost neither the government nor private citizens anything. The government didn’t have to raise taxes or spend any money. The government didn’t regulate or control anything. The government didn’t take from one group of citizens to give to another. All the government did was to promise to sign a piece of paper transferring ownership if, and only if, private investors ponied up the modern equivalent of billions to successfully build a railroad. It was if anything, a devolvement of government power and intrusion.
If that is all the government action it took to increase private investment in “green” technology (or whatever the latest fad will be when you read this) fiscal conservatives and libertarians would be giddy supporters. The conventional story of the railroad land grants gets the story exactly backwards and draws the opposite moral as it should.
That’s why I’m peeved.
IIRC (from a history class very early on which touched on this matter), the lands granted to the builders of the transcontinental railway companies were alternating sections along the planned route of the railway. Which is, considering the route, a nice piece of property, but not exactly the larger chunk of the continent. If I remember the instructor correctly, this resulted in many of the towns originally established as railway stops had a definite egg-shaped outline in the built-up portion – because the building skewed into the alternate sections in which property was cheaper.
The land was granted in a checkered board pattern with alternating squares of railroad grant land and land retained by the government (which was sold to private individuals.)
So, the grants were actually only 50% of what you see on the map.
A peeve of mine, too. I connect it back to the application of tradable property rights. All the riches of North America were worth subsistence value until European kings decided to claim title to chunks of the territory. Land title is an intellectual property, creating value from nothing.
A good point to make about any “investment” in infastructure. What’s the point of building or maintaining a road if there’s no demand for the goods trucks driving on that road carry. Even infastructure is driven by real demand.
I’m glad to see Shannon bring this up. He’s absolutely correct; the grants were conditional offers of worthless land on the condition that they be made worth quite a lot. There were construction subsidies of direct cash payment, which were corrupted, but they were a separate matter from the land grants. (The subsidies came in two rates, the one for mountainous land being larger. The Central Pacific managed, by lobbying, to have the flat-as-pancake land east of Sacramento declared “mountainous” and collected the higher subsidy on it –which gets back to the old issue of metrics in subsidization.)
Two other points. One was that, in addition to the land value, the government also got a 50% discount on all the government’s passenger and freight traffic. This lasted until 1944, when the huge wartime traffic loads were coming close to bankrupting the railroads because of the discount — all those troop trains and flatcars full of tanks went at half price, which was below cost. The government probably made a profit on the whole land grant thing counting nothing more than the discount.
The other was that the precedent for the land grant program was a highly successful land grant deal made only thirty years before — one in which private landowners made land grants to a governmental transportation entity. Landowners in western New York State were only too happy to make land grants to New York State in order to get the Erie Canal built.
The land grants were one of the smartest things the US Government has ever done.
Still, gentlemen, there was a horrendous amount of corruption associated with the whole process.
I’d need to dig into the books to get the details …
Funny that the farmers worked so hard to get railroads to come through, then organized all kinds of protests about the bad behavior of the railroads.
“Funny that the farmers worked so hard to get railroads to come through, then organized all kinds of protests about the bad behavior of the railroads”
Protests about railroad freight rates are becoming strong again, this time from companies doing a lot of shipping/receiving via rail (especially those so unfortunate or unwise as to have facilities served by only one line and no water-transportation alternative)
I think it would be amusing to see the CEOs of DuPont, ADM, etc marching arm in arm and singing old Grange songs about the iniquity of the railroads.
The high freight tariffs were the integral accompaniment of the cheap or free land and transportation most of them received to get there in the first place. They might have done better to lobby for more land grants, to bring competing lines closer to them. The businessmen of Los Angeles got tired of the monopoly fright rates of the Southern Pacific, so they did the effective thing, which was convince the Union Pacific to build a competing line down through Las Vegas. That, plus the contemporaneous construction of the Port of Los Angeles in San Pedro, marked the real takeoff of Los Angeles. As James Belich pointed out, it wasn’t until the Panama Canal started to offer really rock-botton sea freight rates to the East Coast that the West really started to export competitively to the east. Also, once the Canadian Pacific Railway was completed to Vancouver, people began crossing to Vancouver and then going down to West Coast destinations via steamer. International regulatory arbitrage put them beyond the ability of the monopolists to shut down.
The monopolies of the original land-grant railroads were a problem. Generally, arranging competition was a better solution than regulation.
Great note, Shannon.
For similar reasons, I strongly support a Henry James Land Value Tax — the value of land depends hugely on the neighbors (location!).
There was little direct corruption in the land giveaways — but huge corruption/ insider speculation surrounding other aspects.
Leland Stanford of CA comes to mind; too bad “Robber Barons” wasn’t allowed as a team name. But it wasn’t valuable land that was taken/ given.
The land became valuable because of the ownership based investment.
Competition was needed for lower freight prices.
It is interesting to compare the railroads with airlines. Both were seeded by government contracts (mail/ air mail being a big one). Commercial airlines have, in aggregate, never actually made any money. Boeing on the other hand, like the construction companies that built the UP & CP, has made plenty. The truth is it is very hard to make money in a capital intensive business without significant barriers to entry – the economics of sunk capital drive the businesses to cash margins and frequent bankrupcies. The people who pick up the pieces can make money, but the initial investors generally lose.
It is amazing how much of the value created by airlines ends up in the hands of their customers, and in certain cases the markets they serve (think Orlando and Las Vegas). It would cost me easily $1000 and days of my time to drive round trip to Florida from Philadelphia, yet I can buy plane tickets for under $250, on which the airline probably makes less than the taxes on the ticket.
The barriers to entry in railroading are now much higher than in airlines….construction of new track will in most location face lengthy environmental and NIMBY issues, not to mention just the raw cost of acquiring the land and building the right-of-way. Whereas starting a new airline, with leased equipment, isn’t really all that difficult, and people keep getting tempted. (“the triumph of hope over experience”)
I think the main threat to rail profitability right now is the possibility of rate reregulation, spurred by the complaints of rail-dependent industries such as chemicals, agriculture, building products, etc.
The whole idea that transportation companies ought to be profitable on a stand-alone basis is a fallacy driven by 19th century anti-trust theory. A transportation corridor gets its value by raising the value of the real estate it serves, and in a proper market economy the transport operators should be integrated with the real-estate operations that ultimately profit from it. Successful 19th century railroads sold or leased land along their rights-of-way; the power to arbitrarily raise the value of land by choosing to build a station and provide frequent service allowed them to pick and choose what land would become valuable when. Airports raise the value of the land around them enormously — the new “aerotropolis” buzzword is based on this perception. Yet airlines don’t even own their slots or gates in a straightforward fashion, much less have a stake in the terminal or the surrounding land. And although the barriers to entry to the (unprofitable) airline business, the barriers to entry to the airport business are enormous. The current model, of having local governments operate airports but grossly undervalue the gates and slots which are their main product, is absurd.
Japanese privat commuter railroads, which run on the old US interurban electric railway model that was driven out of business by politics, take full advantage of these market realities. They are primarily land companies that astutely exploit the potentials of their transportation corridors.
There is no more reason to expect horizontal transportation segments to be self-supporting than vertical ones. As a thought experiment, consider what the economics of skyscrapers would be like if the elevators had to be built and operated by a separate company and financed entirely by fare collections at the door.
“I strongly support a Henry James Land Value Tax”: Henry George?
The current model, of having local governments operate airports but grossly undervalue the gates and slots which are their main product, is absurd.
In the US, local govts make a similar kind of mistake when they build intra-urban subway/commuter train systems. The routes are determined politically based on current rather than optimal land use patterns. The systems are defined, based on precedent rather than economic analysis, as rights of way whose attached land is a necessary nuisance. Some property owners with property near major stations receive windfalls, either accidentally of because they game the political system. In other cases productive land is made unusable. People with no stake in the system are given veto powers that they use to extort rents. A great deal of value gets destroyed that might have been realized in a rationally designed system, even one run by govt.
“Nature’s Metropolis” talks extensively of this, in terms of the Marxist concept of “second nature” (nature as we have created it).
This goes to Elizabeth’s Warren’s point — no man gets rich on his own. Even the ‘natural’ world is a consequence of earlier application of capital.
The companies building the transcontinental railroad would lay out town lots while they were surveying the road beds and then sell the lots to speculators (including company officials.)
Before the Central Pacific RR even reached the Donner Summit, the Sacramento and San Francisco newspapers were complaining the the CPRR charged more to move a barrel of flour from Sacramento to a town 30 miles away in the Sierra foothills than it cost to ship the same barrel of flour to the dock in Liverpool.
Of course, that was still far less than a mule team would charge but that doesn’t get mentioned.
For modern mass transit designs, one often hears the charge that landowners in the central business district are the prime movers yet want to find ways for the suburbanites to pay the costs of construction and operation.
Still, a valid argument for continued subsidies for suburban railway lines is that once profitable routes now have a large housing and office infrastructure dependent on continued transit operation. Yet, the questions remain, who pays and who benefits?
“… a Henry James Land Value Tax …”
There are amusing literary parodic possibilities here.
“They might have done better to lobby for more land grants, to bring competing lines closer to them.”
That seems closer to the point to me. Shannon makes a good case that the land grants themselves weren’t bad policy. But looking at the map, it appears that the broad swaths of land involved effectively made enormous chunks of the US permanent or near-permanent route monopolies.
Government granted monopolies (in my view the only true monopolies that exist) are always a bad idea. If the federal government were going to use land grants to open up the West, they either needed to allow up front for competing routes, or else put some sort of regulation in place.
Given the perennial problem of regulatory capture, it seems to me that they should have gone for competition. Instead, it looks like they deliberately did the opposite.
I know a lot less about this subject than I’d like to, however. If Shannon or someone else wants to make a case on whether or not the railroads enjoyed artificially high pricing power and barriers to entry, I’m all ears. (Or actually eyes, I guess.)
Railroads were the classic example of what appeared to be “natural monopolies” requiring heavy-handed state intervention.
If you had truly competitive railroads, they engaged in price wars, operated below cost, lost money, ran down equipment, became unsafe and unreliable, causing all kinds of public outcry, until one failed, and was bought out.
When you had a monopolist, it extracted all the surplus out of every transaction and generated a lot of anger from its customers who had no alternative but to use the railroad.
Neither seemed like a happy or sensible outcome.
Hence the outcry for a committee of experts to prevent the “destructive waste” of competition and offsetting “predatory monopoly” of no competition.
Putting a government leash on railroad monopolies was popular and seemed like the only sensible thing to do to many people who were otherwise not enamored of state intervention or control of private enterprise. It just seemed like a unique and special case that also happened to be critically important to the operation of the overall economy.
The matter of railroads, government and copetition keeps rolling on. Evey now and then the idea of a coal slurry pipeline running from the Appalachain coal fields to the east coast is raised. The slurry is essentially a process of turning coal into dust, mixing it with water so it becomes mud, then pumping it to the destination. It is not a bad idea – expensive to build but a whole lot cheaper than rairoads once in operation – but would cause big harm to CSX.
CSX has successfully stopped the proposal every time it comes up through intensive lobbying. In the 1980’s their lobbyist in chief was attorney John Snow, who was rewarded for killing off the most serious coal sluury proposal with the presidency of CSX, where he subsequently led the negotations concerning the breakup of Conrail and divvying it up between CSX and the Norfolk Southern. He then went frm CSX to become Treasury Secretary under George W.
The relationahip between the rairoads and the federal government is as close and questionable as ever.
When I was a kid, you could get on the Burlington and follow the path from Crete to Kenesaw alphbetically (it started earlier and end much later). Before the railroads there were no towns every few miles to stop for water; after the railroad, there were towns and farms and a place to send harvests. If you want positive looks at those times, look at Willa Cather’s Lost Lady (the admirable railroad guy that is treated as a mythic hero is the kind of guy that saw what could happen and made it happen; he’s also the guy that when a bank he’d invested in was going to go under and take the money of the men who’d banked there because of his name, took his fortune and put it in to make their demands good) or look at Jim, the narrator of My Antonia. In the introductory few pages where we see him objectively for the only time his role as a railroad man with an imagination that could see the strength of other’s dreams led to building industries in the west.) I don’t know enough about the history to argue for the railroad and by the time I was growing up the featherbedding had assumed absurd proportions, but I also know there would have been no Blue River Conference of small schools along the Platte if there had been no railroad – and I’m not sure what would have happened to those huge groups of immigrants and those somewhat alienated southerners coming west who settled those areas.
In Nothing Like It In the World, Stephen Ambrose says that he began thinking it was going to be a story of greed and he ended up deeply appreciating the men who built those railroads.
For those interested in a working-level view of the railroad industry, I recommend Linda Niemann’s On The Rails, which I reviewed here.
A great book about the building of the transcontinential railroad is “Empire Express.”
It mixes engineering, politics, finance, indian wars, diet, and geography with project management. Loved it.
With all the talk of “shovel-ready infrastructure projects” lately, it is enlightening that the president of the Union Pacific RR during its construction phase also was the owner of the country’s largest shovel manufacturer.
The railroads opened the West but there were many bankruptcies. I was puzzled when I saw the assertion about railroads.
One the other hand:
a private success The Great Northern’s route was the northernmost transcontinental railroad route in the United States and was north of the Northern Pacific Railway route. It was completed on January 6, 1893, at Scenic, Washington.
The Great Northern was the only privately funded, and successfully built, transcontinental railroad in United States history. No federal land grants were used during its construction, unlike every other transcontinental railroad built. It was one of the few transcontinental railroads to avoid receivership following the Panic of 1893.
(Wikipedia):