Collective hallucinations and inefficient markets: The British Railway Mania of the 1840s Andrew Odlyzko School of Mathematics and Digital Technology Center University of Minnesota [email protected] http://www.dtc.umn.edu/∼odlyzko Preliminary version, January 15, 2010 Abstract. The British Railway Mania of the 1840s was by many measures the greatest technology mania in history, and its collapse was one of the greatest financial crashes. It has attracted surprisingly little scholarly interest. In par- ticular, it has not been noted that it provides a convincing demonstration of market inefficiency. There were trustworthy quantitative measures to show in- vestors (who included Charles Darwin, John Stuart Mill, and the Bront¨esisters) that there would not be enough demand for railway transport to provide the ex- pected revenues and profits. But the power of the revolutionary new technology, assisted by artful manipulation of public perception by interested parties, in- duced a collective hallucination that made investors ignore such considerations. They persisted in ignoring them for several years, until the lines were placed in service and the inevitable disaster struck. In contrast to many other bubbles, the British Railway Mania had many powerful, vocal, and insightful critics. But the most influential of them suffered from another delusion, which misled them about the threat the Mania posed. As a result, their warnings were not persuasive, and were likely even counter- productive, as they may have stimulated increased investments. The delusions that led to the financial disaster of the Railway Mania arose from experience with the railway mania of the mid-1830s. Seldom even men- tioned in the literature, it was about half the size of the big Railway Mania of the 1840s (and thus still far larger than the Internet bubble). The initial finan- cially exuberant phase of it did collapse. But it appears to have been unique among large manias in that a few years later it was seen as having collapsed prematurely, as projects started during its exuberant phase became successful. That mania demonstrates the difficulty in identifying bubbles that are truly irrational. Both railway manias provide a variety of other lessons about the interaction of technology and financial markets. – Main text: 187 pages. – Appendices: 63 pages. – Endnotes: 54 pages. Table of Contents 1 Introduction ...................................... ..................... 4 2 The Railway Mania and history .......................... ................ 22 3 British economy of the Railway Mania period . ................ 30 4 Economic and financial history of early railways . .................. 37 5 The investment bubble of the mid-1820s .................. ................. 41 6 The 1830 revolution in the railway industry . .................. 46 7 The investment mania of the mid-1830s and its outcome . ............... 52 8 The railway mania of the 1830s and its opponents . ................. 54 9 Railways after the crash of 1837 ........................ .................. 63 10 A prelude to the Railway Mania: From stasis to ten-fold expansion............ 70 11 A brief chronology of the Railway Mania and sources of investor losses . 77 12Opponents of the Railway Mania ....................... .................. 81 12.1 The Times anditsthunder...................................... ..... 86 12.2 The Economist and fixed and floating capital ........................... 89 12.3 James Morrison and “small profits and quick returns” . ............. 91 12.4Effect of Mania opponents .......................... ................. 95 13 The reliably unreliable engineers . ....................... 97 14 Tacit collusions and beautiful illusions . ...................... 103 15 Economic growth: Quantum jumps or slow and steady development? .......... 110 16Theworldislocal .................................. .................... 120 17 Collective delusions about revenue estimates . .................... 128 18 The astounding demand estimation accuracy of the 1830s . ................ 132 19 The origins and spread of demand forecast delusions . ................ 135 20Ignoring the past and the future ....................... ................... 140 21 Investor expectations: Size of network . .................... 141 22 Investor expectations: Profit rates.................... ..................... 145 23 The success and failure of the traffic takers............... .................. 147 24Fallacies of the traffic takers ........................ ..................... 149 25 Parliamentary contests and the elimination of traffic takers................... 156 26The reputation of the traffic takers.................... .................... 167 27 The fatal fallacy of the Railway Mania . ................... 171 28Prophets of a profitless future ........................ .................... 178 29 James Morrison’s amazing forecast . ................... 179 30 Dionysius Lardner, the reticent Cassandra . .................. 181 31Conclusions....................................... ..................... 188 Appendix 1: The Glenmutchkin Railway byW.E.Aytoun ...................... 191 Appendix 2: Gaps in British railway history literature . ................... 211 Appendix 3: The British Press and other information sources . ............... 215 Appendix 4: Railway promotion and governance . .................. 221 Appendix 5: The Berwick and Kelso Railway: Shareholder skepticism in the 1830s . 225 Collective hallucinations and inefficient markets 3 Appendix 6: The Atlas on markets and railway speculation in 1844 . 229 Appendix 7: William Aytoun and 1845 railway promotions . ............... 231 Appendix 8: Economic growth (mis)conceptions . .................. 234 Appendix 9: Locality of railway traffic .................... ................... 242 Appendix 10: William Chaplin: Fool or rogue? . .................. 250 Endnotes ........................................... ..................... 254 Acknowledgments ..................................... .................... 308 References ......................................... ...................... 310 List of Figures 1 Railways authorized in the United Kingdom from 1830 to 1850. Not all were built. 6 2 Railway investment in the United Kingdom from 1830 to 1850. ............. 7 3 Railway share prices in Britain from 1830 to 1850. ................. 7 4 Gross Domestic Product at current prices in the United Kingdom from 1830 to1870............................................. ................... 31 5 Competitive aspects of railway demand estimation not captured by traffic taker methodology. .................................. ................... 155 List of Tables 1 British economy, 1830–1860. ................... 32 2 British railway industry statistics, 1830–1860. .................. 34 3 Rough comparison of British economy of 1845 to U.S. economy of 2009. 35 4 Edinburgh and Glasgow Railway, revenue estimates and actual results. 50 5 Revenues of main LSWR line............................ ................. 116 6 Railway estimates of 1836 and results of 1843 for six prominent British railways. 133 7 Liverpool and Manchester Railway data. ................. 235 8 Stage-coaches in Britain, 1836–49. ..................... 296 4 Andrew Odlyzko 1 Introduction The British Railway Mania of the 1840s was a giant event. At its height, individual capital- ists, in pursuit of private profit, were plowing more than twice as much into the construction of a public infrastructure as their nation was spending on the military. (It should be noted that the Pax Britannica was not cheap. Among other foreign adventures, Britain had just a few years earlier been involved in the First Opium War and the First Afghan War.) During the peak year for spending, 1847, their investments came, as a fraction of Gross Domestic Product (GDP), to the equivalent of over $1 trillion dollars for the United States today. (If we compare their expenditure to total government spending, federal, state, and local, and not to GDP, it was equivalent to over $3 trillion dollars. Taxes, which might be thought of as proportional to discretionary incomes, were far lower at that time than today.) All the funding came from individuals making private decisions to commit their funds to the new enterprise. Those investors, most new to share markets, involved such scientific and literary luminaries as Charles Darwin, Charles Babbage, John Stuart Mill, the Bront¨esisters and William Makepeace Thackeray, as well as such prominent politicians (directly or through their close families) as Disraeli, Gladstone, Palmerston, and Peel. Many famous figures were involved with the Mania in other ways. For example, Herbert Spencer, in an early stage of his career, was a railway engineer during the financially most exuberant phase of the Mania. While he appears not to have invested in it himself, he managed to persuade his father to sell out close to the peak of the market. Most investors did not fare so well, and their hopes for bountiful profits were grievously disappointed. The peak of the Mania excitement was followed by several years of heavy investment accompanied by a slow and agonizing slide in the stock markets. At the end of 1849, just as railway shares were touch- ing their lowest level of that decade (and of the remaining decades of the 19th century), Charlotte Bront¨ewrote: My Shares are in the York & North Midland Railway. ... The original price of Shares in this Railway was £50. At one time they rose to 120; and for some years gave a dividend of 10 per cent; they are now