The London School of Economics and Political Science Was the first transcontinental railroad expected to be profitable? Evidence from entrepreneur’s declared expectations, an empirical entry decision model, and ex-post information Xavier H. Duran A thesis submitted to the Department of Economic History of the London School of Economics for the degree of Doctor of Philosophy, London, January 2010 1 UMI Number: U511857 All rights reserved INFORMATION TO ALL USERS The quality of this reproduction is dependent upon the quality of the copy submitted. In the unlikely event that the author did not send a complete manuscript and there are missing pages, these will be noted. Also, if material had to be removed, a note will indicate the deletion. Dissertation Publishing UMI U511857 Published by ProQuest LLC 2014. Copyright in the Dissertation held by the Author. Microform Edition © ProQuest LLC. All rights reserved. This work is protected against unauthorized copying under Title 17, United States Code. ProQuest LLC 789 East Eisenhower Parkway P.O. Box 1346 Ann Arbor, Ml 48106-1346 Declaration I certify that the thesis I have presented for examination for the MPhil/PhD degree of the London School of Economics and Political Science is solely my own work other than where I have clearly indicated that it is the work of others (in which case the extent of any work carried out jointly by me and any other person is clearly identified in it). The copyright of this thesis rests with the author. Quotation from it is permitted, provided that full acknowledgement is made. This thesis may not be reproduced without the prior written consent of the author. I warrant that this authorization does not, to the best of my belief, infringe the rights of any third party. 2 Acknowledgements I was fortunate to enjoy the support of a wide group of people to complete this thesis and would like to acknowledge my gratefulness here. The LSE offered a stimulating environment to develop my own research. I am indebted to my supervisors Nick Crafts, Tim Leunig and Henry Overman for the conversations, encouragement and guidance they provided. I was fortunate to learn from each one of them. I am grateful to Patrick O’Brien for opening the doors to an enjoyable and productive relationship. I am thankful to the whole faculty and group of graduate students, especially Carlos Brando and Felipe Tamega, with whom I had the privilege to interact and collaborate. This thesis would not have been possible without a successful field work. The UC- Davis Institute of Governmental Affairs, Greg Clark, Peter Lindert, Shelagh Matthews, Chris Meissner, Alan Taylor, and, particularly, Alan Olmstead all facilitated my work in California by generously providing infrastructure and an enthusiastic academic environment. The staff at the Newbery Library, UC-Berkeley Bancroft Library, UC-Davis, Stanford University, Kristine Ogilvie at California State Library, Luis Martinez and Eugenia Gonzalo at London School of Economics, Kay Geary and Roberto Sarmiento at Northwestern University, and John Bromley at the Union Pacific Railroad Museum provided access and guidance to a wealth of archival material. Kyle Wyatt at the California State Railroad Museum shared his knowledge of the history of the railroad and indicated relevant material in several organizations. Martha Amorocho kept the California roots alive for me. The LSE, Acworth Foundation and Rosebery Foundation provided funding through research studentships. The Economic History Society, the Radwan Fund and the Royal Historical Society financed field work activities. Their support was indispensable for the completion of this thesis and is gratefully acknowledged. The thesis has also nurtured from discussions with a wider community. Jeremy Atack and Dan Bogart examined my thesis, made very helpful and encouraging suggestions. Joel Mokyr made very stimulating and support comments. Thanks to Cecile Aubert, James Bushnell, Lou Cain, William Childs, Albert Churella, Stanley Engermann, Joe Feme, Robert Fogel, Knick Harley, William Hausman, Peter Howlett, Janet Hunter, Stephen Maurer, Larry Neal, Douglass North, Antoine Reberiox, Albretch Ritschl, Nathan Rosenberg, Alejandro Sanz de Santamaria, Suzanne Scotchmer, Nick von-Tunzelmann, Patrick Wallis and Richard White for influential conversations. Most important, I am grateful to my wife and parents. My wife, Chiqui, initiated the London adventure and shared with me this English/doctoral journey. Her support, encouragement, patience, and smile were indispensable to reach completion. My parents Maria Lucia and Hernando taught me the joy of intellectual curiosity. Without their continuous encouragement, example, and advice I may have chosen a different path. 3 ABSTRACT The construction of the first transcontinental railroad is a key event in the westward expansion of the rail network and the US economy. The railroad was built between 1863 and 1869 with large federal government subsidies. The standard view is that the railroad was not expected to be profitable (built ahead of demand) but turned out to be profitable (built after demand). The thesis develops a novel approach to evaluate whether the first transcontinental railroad was expected to be profitable. The approach emphasises on using information generated during the ex-ante period and comparing it to ex-post information. The ex-ante information comes from two different sources. First, reports written by entrepreneurs (and overlooked by previous literature) are used to identify entrepreneurs’ declared expectations. Second, since such expectations could be different from entrepreneurs’ true beliefs, an empirical entry decision model is used to evaluate the plausibility of declared expectations - simulated expectations. The ex-post information was revealed by the operation of the railroad, once built. The three sets of information (entrepreneur’s declared expectations, simulated expectations, and observed performance) are compared to identify unforeseen events that may have affected profitability. The evidence indicates the railroad was expected to be profitable, and thus it was both ex-ante and ex-post built after demand. Subsidies may have still helped to promote construction during the Civil War. 4 TABLE OF CONTENTS CHAPTER 1. INTRODUCTION ..................................................................................................................................9 CHAPTER 2. BUILDING AHEAD OF DEMAND AND THE PACIFIC RAILROAD ............... 22 2.1. Introduction .......................................................................................................................................................22 2.2. T h e p r o b l e m : B u il d in g a h e a d o f d e m a n d .......................................................................................22 2.2.1. The Problem........................................................................................................................ 23 2.2.2. Importance o f the Pacific Railroad.................................................................................. 28 2.3. The approach follow ed by econom ic historians to study the decision to build A RAILROAD......................................................................................................................................................................32 2.3.1. Building ahead o f demand................................................................................................. 32 2.3.2. Market equilibrium, building ahead o f demand, and empirical testing....................... 35 2.3.3. Coexistence o f building following demand, ahead o f demand and railroad construction booms....................................................................................................................... 40 2.3.4. The evidence on the entrepreneurial decision to build the Pacific Railroad................ 44 2.4. E v a l u a t io n o f t h e l it e r a t u r e ................................................................................... 53 2.5. A p p r o a c h ...............................................................................................................................................................63 2.6. C o n c l u s io n s ........................................................................................................................................................ 69 CHAPTER 3. EX-ANTE ENTREPRENEURIAL ACTIVITY AND THE PACIFIC R A IL R O A D A S A S IN G L E S T A G E P R O J E C T ..............................................................................................71 3.1. Introduction .......................................................................................................................................................71 3.2. A R a il r o a d t o t h e P a c if ic ..........................................................................................................................73 3.2.1. Antecedents.......................................................................................................................... 73 3.2.2. Whitney’s Railroad to the Pacific...................................................................................... 75 3.3. C o m p e t it io n t o b u il d t h e P a c if ic R a il r o a d ................................................................................ 85 3.4. C o m p e t it io n t o p r o f it f r o m transporting t r a d e t o a n d f r o m t h e P a c if ic O c e a n ...............................................................................................................................................................................