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ImpriOVER 2,500,000mi READERS MOsNTHLY *ULY!UGUST s 6OLUME .UMBER !" th Annive#ary Economic Lessons from American History *OHN 3TEELE 'ORDON !UTHOR !N %MPIRE OF 7EALTH 4HE %PIC (ISTORY OF !MERICAN %CONOMIC 0OWER
JOHN STEELE GORDON was educated at Millbrook School and Vanderbilt University. His articles have appeared in numerous publications, including Forbes, Worth, National Review, Commentary, the New York Times, and the Wall Street Journal. He is a contributing editor at American Heritage, where he wrote the “Business of America” column for many years, and currently writes “The Long View” column for Barron’s. He is the author of several books, including Hamilton’s Blessing: The Extraordinary Life and Times of Our National Debt, The 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 Constant, Discovery, 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. (),,3$!,% #/,,%'% 05235).' 4254( s $%&%.$).' ,)"%249 3).#%
This astonishing economic transforma- Going back even farther, to the dawn tion provides rich lessons in examples of of the industrial age, consider the Erie what to do and not do. Let me suggest five. Railway. In order to get political support for building the Erie Canal, Governor 1. Governments Are Terrible Investors DeWitt Clinton promised the New York counties that bordered Pennsylvania When the Solyndra Corporation filed for (known as the “Southern Tier”) an bankruptcy last summer, it left the tax- “avenue” of their own once the canal was payers on the hook for a loan of $535 mil- completed. The canal was an enormous lion that the government had guaranteed. success, but as such it affected the state’s In a half-billion-dollar example of how politics. A group of politicians from along governments often throw good money its pathway, the so-called Canal Ring, after bad, the government had even soon dominated state government. They agreed to subordinate the loan as the com- were not keen on helping to build what pany’s troubles worsened, putting taxpay- would necessarily be competition. ers at the back of the line. In retrospect, A canal through the mountainous ter- it is clear that the motive behind the loan rain of the Southern Tier was impossible, guarantee was political: to foster green and by the 1830s, railroads were the hot energy, an obsession of the left. And that’s new transportation technology. But only the problem with government investment: with the utmost effort did Southern Tier Politicians make political decisions, not politicians induce the Legislature to grant economic ones. They’re playing with other a charter for a railroad to run from the people’s money, after all. Hudson River to Lake Erie through their History is littered with government counties. And the charter almost guaran- investment disasters. teed economic failure: The Clinch River It required the railroad Imprimis IM PRI MIS −´ Breeder Reactor, for ;,ATIN= IN THE FIRST PLACE to run wholly within instance, authorized New York State. As a EDITOR in 1971, was estimated $OUGLAS ! *EFFREY result, it could not have to cost $400 million DEPUTY EDITORS its eastern terminus in 2EBECCA "URGESS to build. The project 4IMOTHY 7 #ASPAR New Jersey, opposite ran through $8 bil- COPY EDITORS New York City, but had %MILY 3ARVER lion before it was -ONICA 6AN$ER7EIDE to end instead in the canceled, unbuilt, in ART DIRECTOR town of Piermont, 20 1983. A half century !NGELA % ,ASHAWAY miles to the north. It was MARKETING DIRECTOR earlier, the Woodrow &RED (ADRA also forbidden to run to Wilson administra- PRODUCTION MANAGER Buffalo, where the Erie tion thought it could ,UCINDA 'RIMM Canal entered Lake Erie, CIRCULATION MANAGER produce armor 7ANDA /XENGER terminating instead plate for battleships STAFF ASSISTANTS in Dunkirk, a town 20 2OBIN #URTIS cheaper than the steel +IM %LLSWORTH miles south. Thus it +ATHY 3MITH companies. The plant -ARY *O 6ON %WEGEN would run 483 miles the government built, between two towns millions over budget #OPYRIGHT Ú (ILLSDALE #OLLEGE of no importance and 4HE OPINIONS EXPRESSED IN Imprimis ARE NOT when completed, NECESSARILY THE VIEWS OF (ILLSDALE #OLLEGE through sparsely settled could not produce 0ERMISSION TO REPRINT IN WHOLE OR IN PART IS lands in between—not HEREBY GRANTED PROVIDED THE FOLLOWING CREDIT armor plate for less LINE IS USED h2EPRINTED BY PERMISSION FROM unlike the current pro- than twice what Imprimis A PUBLICATION OF (ILLSDALE #OLLEGEv posed California high- SUBSCRIPTION FREE UPON REQUEST. the steel companies )33. speed rail project, the charged. In the end it Imprimis TRADEMARK REGISTERED IN 53 first segment of which produced one batch— 0ATENT AND 4RADEMARK /FlCE would run between later sold for scrap— Fresno and Bakersfield and shut down. and cost $9 billion. 2 *5,9!5'534 s 6/,5-% .5-"%2 < hillsdale.edu
The Erie Railway was initially esti- An audio version of Imprimis mated to cost $4,726,260 and to take five is available online at years to build. In fact, it would take $23.5 hillsdale.edu/imprimis million and 17 years. With the depres- sion that began in 1837, it soon became commerce. Anyone can use them for a clear that only massive state aid would fee, although many Interstates are paid see the project through. So New York for through the Highway Trust Fund. State agreed to put up $200,000 for every But a railroad is a business that can only $100,000 raised through stock sales. Even be profitable with careful attention to that was not enough, however, and the the bottom line forced by competition. railroad issued a blizzard of first mortgage And governments are notoriously bad at bonds, second mortgage bonds, convert- running businesses because government ible bonds, and subordinated debentures businesses are always monopolies. Just to raise the needed money. This mountain remember your last customer-friendly of debt got the Erie completed in 1851, but visit to the Department of Motor Vehicles. it would haunt the railroad throughout its In addition to building infrastructure existence. Indeed, the Erie Railway would such as the Erie Canal and the Interstate pass through bankruptcy no fewer than Highway System, government can be six times before it disappeared as a corpo- good at doing basic research, such as in rate entity in the early 1970s. space technology, where the costs were far Why was the Erie Canal a huge suc- beyond the reach of any private organiza- cess—it even came in under budget and tion. Only government resources could ahead of schedule—that made huge prof- have put men on the moon. Nevertheless, its from the very beginning, while the I’m encouraged to see that the next gen- Erie Railway was a monumental failure? eration of rockets is being developed by One reason was that canal technology private companies, not NASA. That’s a was well-established and well-understood step in the right direction. by the early 19th century. More impor- Unfortunately, we are headed the other tant, the route of the Erie Canal was the way with the American medical industry. only place a canal could be built through the Appalachian Mountains. Thus it 2. Politicians Have Self-Interest Too would have no competition. And the reason the canal was built by government In 1992, New York State found itself $200 was that the project was simply too big for million short of having a balanced bud- a private company to handle. get, which the state constitution requires. A very similar situation arose in the The total state budget was about $40 1950s. Three decades before, a young billion, so it could have been balanced U.S. Army captain had joined an expedi- by cutting one half of one percent—the tion in which the Army had sent a large equivalent of a family with an after-tax convoy of trucks from Washington to San income of $100,000 finding ways to save Francisco, to learn the difficulties of doing less than 50 dollars a month. so. They were very considerable because So did New York cut its budget? Don’t the nation’s road network hardly deserved be silly. Instead, it had a state agency issue the term. By the 1950s, that young captain $200 million in bonds and use the money had become president of the United States to buy Attica State Prison from the state. and road-building technology was well The state took the $200 million its own understood. Dwight Eisenhower pushed a agency had borrowed, called it income, and national network of limited-access roads declared the budget balanced. New York through Congress, and the country has now rents the prison from its own agency hugely benefitted from the Interstate at a price sufficient to service the bonds. Highway System ever since. Had any private company sold, say, its Both the Erie Canal and the Interstate corporate headquarters to a wholly-owned Highway System are passive carriers of subsidiary and called the money received PHOTO ALBUM H!""#$%"& C'""&(& C)*!#&
Rio de Janeiro to Buenos Aires F!"#$%#& - M%#)* ,
Hillsdale cruisers on the belvedere beneath Bing West, former Assistant Secretary of Rio de Janeiro’s Christ the Redeemer statue Defense in the Reagan administration, at a book signing following an on-board lecture
Hillsdale President Larry P. Arnn and guest A shore excursion in Buenos Aires speaker David Pryce-Jones enjoy a dinner at sea included a visit to La Recoleta Cemetery with Hillsdale cruisers and the tomb of Evita Perón
income, its management would be in keep dishonest ones—so it’s important Club Fed. So why wasn’t Governor Mario that all companies keep them the same Cuomo or the state comptroller thrown in way, so that they can be compared and jail for what was a patent act of account- a company’s true financial picture seen. ing fraud? Because government, unlike Second, these firms were required to have corporations, can keep their books as they their books certified as honest and com- please. And why must corporations obey plete by independent accountants. It was accounting rules? In a beautiful example at this time that accountancy became an of Adam Smith’s invisible hand at work, it independent, self-governing profession, was the self-interest of Wall Street bankers like law and medicine. and brokers that produced one of the great But while J. P. Morgan was probably the ideas in American economic history. most powerful banker who has ever lived, In the 1880s the great Wall Street banks not even he had the power to force govern- that were emerging at that time, such as J. ments to adhere to Generally Accepted P. Morgan & Co. and Kuhn Loeb, as well Accounting Principles and submit their as the New York Stock Exchange, began books to independent certification. And demanding two new ways of doing busi- because it is in the self-interest of politi- ness: First, listed firms, and those hoping cians to cook the books—just as corporate to raise capital through the banks, were managers did until Wall Street forced them required to keep their books according to change their ways—they continue to to what became known as Generally commit accounting fraud on a massive Accepted Accounting Principles. There are scale. This is no small part of the reason many ways to keep honest books—and, that the federal government and many state of course, an infinite number of ways to governments are in financial crisis today. *5,9!5'534 s 6/,5-% .5-"%2 < hillsdale.edu
In 1976 New York City went broke, burgeoning eastern cities. Western states thanks to spending borrowed money and later pressured the federal government to hiding the fact by means of fraudulent limit and even exclude immigration from accounting. The state refused to help China and Japan. In the 1920s we limited until the city agreed to do two things: all immigration, trying to make the eth- adhere to Generally Accepted Accounting nic mix that was then in place permanent. Principles and have its books certified by To be sure, we need to secure our independent accountants. What a concept! borders. All sovereign governments have Needless to say, the state imposed no such a right and a duty to decide who gets to discipline on itself. So here we are, 36 years come in. But it is entirely in our interest to later, and the city is in pretty good finan- allow in those who want to work hard and cial shape while the State of New York is a succeed, for that makes us all richer. And financial basket case, almost as badly off as in a time when by far the most precious California. Maybe New York City should economic asset is human capital (a phrase offer to help the state—once, of course, it not coined until the mid-18th century), agrees to keep honest books. turning away those who possess it makes no sense. In particular, current regulations 3. Immigration is a Good Thing regarding H-1B visas and visas issued to foreign postgraduate students at American Everyone living today in the United States universities often force the holders to either has ancestors who said goodbye to return to their native countries after they everyone and everything they had ever finish their studies or the particular job for known, traveling to a strange land in which they were admitted. Many of these search of a better life, or did so himself. highly educated and highly skilled people That takes a lot of guts and a lot of gump- wish to stay. Instead of letting them, we tion. Both are inheritable qualities. send them back to work in economies that The French and Spanish governments, compete with us. That’s nuts. far more authoritarian than the British, were very careful about who they permit- 4. Good Ideas Spread, Bad Ones Don’t ted to emigrate to their colonies. They wanted no troublemakers, no dissidents, In colonial times we had a chaotic money and especially no religious heretics. The supply. Britain forbade the export of British government, on the other hand, British coins, so while American colonists couldn’t have cared less who went to its kept their accounts in pounds, shillings, colonies. The result was a remarkably and pence, what circulated in day-to-day feisty mix of people. Many just marched transactions was a hodgepodge of Spanish, to the beat of a distant drummer. More French, Portuguese, and some British coins, than a few arrived one jump ahead of warehouse certificates for tobacco and the sheriff—and others one jump behind other products, paper money printed by him, having been transported as crimi- the colonies—until the British government nals. But the bulk came of their own free forbade that too—and even wampum, the will, and have been coming ever since, form of money used by the Indians. in hopes of finding a better and richer After the Revolution, the need to life. Even those who arrived as slaves, create a national money supply was an and thus had no choice about it, survived urgent task of the new nation. The ques- an ordeal that is utterly beyond modern tion of what unit of account to adopt was imagination and passed that incredible a complex one because the colonists were strength down to their descendants. accustomed to so many different, and But while immigration made this often incommensurate, units. Robert country, there has been a long history of Morris, who had done so much to keep anti-immigration in America, beginning the Revolution financially afloat, tried to as early as the 1840s when the Irish, flee- bridge the differences by finding the low- ing the famine, began to pour into our est common divisor of the monetary units (),,3$!,% #/,,%'% 05235).' 4254( s $%&%.$).' ,)"%249 3).#%
encountered in each state, calculating this unless the debt was considerable. to be 1/1,440th of a Spanish dollar. He The American Rule was a relatively proposed that this unit be multiplied by minor anomaly in our legal system until 1000, making the new American mon- the mid-20th century. But since then, as etary unit equal to 25/36ths of a Spanish lawyers’ ethics changed and they became dollar. Thomas Jefferson—whose role in much more active in seeking cases, the this process amounted to his one and only American Rule has proved an engine of positive contribution to the financial sys- litigation. For every malpractice case filed tem of the United States—argued instead in 1960, for instance, 300 are filed today. In for simply using the dollar. practice, the American Rule has become Once the dollar was chosen, it an open invitation, frequently accepted, to would have been natural to adopt the legal extortion: “Pay us $25,000 to go away British system of dividing the basic unit or spend $250,000 to defend yourself suc- into twenty smaller units, and those cessfully in court. Your choice.” into twelve still smaller units, the way Trial lawyers defend the American American merchants kept their accounts. Rule fiercely. They also make more politi- The Spanish system in use in the colo- cal contributions, mostly to Democrats, nies—cutting dollars into halves, quar- than any other set of donors except labor ters, and eighths, called bits—would have unions. One of their main arguments for been a natural idea as well. But Jefferson the status quo is that the vast number of advocated making smaller units decimal lawsuits from which they profit so hand- fractions of the dollar, arguing that “in all somely force doctors, manufacturers, and cases where we are free to choose between others to be more careful than they oth- easy and difficult modes of operation, it is erwise might be. Private lawsuits, these most rational to choose the easy.” lawyers maintain, police the public mar- That made Jefferson the first person ketplace by going after bad guys so the in history to advocate a system of decimal government doesn’t have to—a curious coinage, and the United States the first assertion, given that policing the market- country to adopt one. This was a very place has long been considered a quintes- good idea, and, as good ideas always do, sential function of government. it quickly spread. Today every country on The reason for this is that when policing earth has a decimal currency system. has been in private hands, self-interest and But if Jefferson’s decimal coinage con- the public interest inevitably conflicted. cept was a good idea that quickly spread The private armies of the Middle Ages all around the world, another idea that devel- too often turned into bands of brigands or oped here at that time was lousy: the so- rebels. The naval privateers who flourished called American Rule, whereby each side in the 16th to 18th centuries were also pri- in a civil legal case pays its own court costs vate citizens pursuing private gain while regardless of outcome. This was different performing a public service by raiding an from the English system where the loser enemy’s commerce during wartime. In the has to pay the court costs of both sides. War of 1812, for instance, American priva- The American Rule came about as teers pushed British insurance rates up to what might be called a deadbeat’s relief 30 percent of the value of ship and cargo. act. The Treaty of Paris (which ended the But when a war ended, privateers had a bad American Revolution) stipulated that habit of turning into pirates or, after the British creditors could sue in American War of 1812, into slavers. courts in order to collect debts owed Predictably, the American Rule has them by people who were now American spread exactly nowhere since its inception citizens. To make it less likely that they at the same time as the decimal coinage would do so, state legislatures passed system. There is not another country in the the American Rule. With the British common-law world that uses it. Indeed, the merchant stuck paying his own court only other country on the planet that has costs, he had little incentive to go to court a version of the American Rule is Japan, *5,9!5'534 s 6/,5-% .5-"%2 < hillsdale.edu where a very different legal system makes it habit of changing his mind. While highly extremely difficult to get into court at all. intelligent, he was no student of econom- The United States has more lawyers ics and seldom read books as an adult. So and more lawsuits, per capita, than any much of his program was, essentially, seat- other country. But lawsuits don’t create of-his-pants policy. First there was the wealth, they only transfer it from one party National Recovery Administration, which to another, with lawyers taking a big cut amounted to a vast cartelization of the along the way. Few things would help the American economy. When the Supreme American economy more than ending the Court threw it out—by a unanimous American Rule. Texas reformed its tort law vote—FDR moved on to other remedies, system a few years ago and the results have including big tax increases on the rich. been dramatic. Doctors have been moving But markets, which can function even into the state, not out of it, and malpractice in disaster with ruthless efficiency, hate insurance costs have fallen 25 percent. And uncertainty. When uncertainty regarding remember, good ideas always spread. the future is high, they tend to tread water. As a result, there was what is known as 5. Markets Hate Uncertainty a “strike of capital.” While corporations often had large cash balances—General The Great Depression that started in the Motors made a profit in every year of the fall of 1929 ended, at least technically, Great Depression—and banks had money in early March 1933. The stock market, to lend, there was little investment and few almost always a leading indicator, had bot- loans made. Both the banks and the cor- tomed out the previous June, down 90 per- porations were too uncertain about what cent from its high in September 1929. 1933 the government was going to do next. would be the second best year for the Dow That is precisely what is happen- Jones average in the entire 20th century, ing today. Banks and corporations have coming off, of course, a very low base. plenty of money. Apple alone is sitting But recovery was very slow in com- on about $100 billion worth of corporate ing. Unemployment, over 25 percent in cash. And yet the recovery from the crash 1933, was still at 17 percent as late as 1939. of 2008 has been tepid at best. The valley Indeed, in 1937, when the economy sud- is U-shaped. Undoubtedly a big reason denly turned south again, there was a for that is the enormous uncertainty that problem: what to call the new downturn. has plagued the country since 2008. Will Most people thought the country was still health care—one-sixth of the American in a depression, so that word wouldn’t do. economy—be taken over by the folks who But economists, delighted to have a prob- run the post office? Will the Bush tax lem that they could actually solve, came up cuts be ended or continued? Will the cor- with the word “recession,” and that’s what porate income tax go up or down? Will we have been using ever since. manufacturing get a special tax deal? Will Usually, when there has been a steep so-called millionaires—who, when you decline in economic activity, recovery is listen carefully to what liberal politicians equally steep. The valley is V-shaped. That are saying, can earn as little as $200,000 is what happened in 1920, when there had a year—be forced suddenly to pay “their been a severe post-war fair share”? depression and then Who knows? So a strong recovery. So DID YOU KNOW? firms and banks are why was the recovery /VER CITIZENS REGISTERED FOR postponing invest- (ILLSDALES FREE ONLINE COURSE h#ONSTITUTION so slow in the 1930s? 4HE -EANING AND (ISTORY OF THE ment decisions until One reason, according #ONSTITUTION v LAST SPRING "EGINNING the future is clearer. IN 3EPTEMBER (ILLSDALE WILL OFFER TWO to an increasing num- ADDITIONAL FREE ONLINE COURSES 7ATCH FOR ber of economic histo- DETAILS AT HILLSDALEEDU rians, is that Franklin Roosevelt had a bad