A Tale of Two Tycoons

by Don Boudreaux on May 20, 2009

in History, Innovation, Intervention

This history lesson will get you steamed.

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{ 33 comments }

Methinks May 20, 2009 at 4:22 pm

I read the headline and let me stop you right there…..

PREVIOUSLY government was not able to run anything because we didn't have "the right guy" in office. Now that we have "the right guy", he can run everything and it'll be better than before. Tim Geithner just needs to get off his butt and hire some people at Treasury already. Strange how nobody wants to work there though….

CRC May 20, 2009 at 4:31 pm

Methinks, I assume you are being facetious about the "right guy" and all that, because I surely wonder if, even at the Treasury Department level, whether a guy who can't figure out his taxes can possibly be "the right guy" for that department.

indiana jim May 20, 2009 at 5:26 pm

Folsom's book "The Myth of the robber barons" discusses Rockefeller; those who characterize him as a robber baron, playing off Don's "steamed", deserve to be boiled in oil.

:>)

Jeff May 20, 2009 at 5:55 pm

I might suggest a response to the WSJ:

Dear WSJ: You can not use a single qualitative example to generalize to a larger population. We get murdered in a thesis defense for using arguements like that.

Methinks May 20, 2009 at 6:06 pm

What? I would never ever be facetious about our elegant CEO in chief. Now, if you'll excuse me, Obama is about give another "I have a Plan" speech. This one's about housing. I think it's called "Renters and Savers are Suckaaas".

See? Obama knows which ships will sail and which won't. He knows because he chooses winners and losers. Never mind figuring out Dim Geithner's taxes.

The Albatross May 20, 2009 at 7:13 pm

We might also consider the example of powered flight. The government subsidized Samuel Langley to the princely sum of $53,000, while ignoring a couple of bicycle merchants from Ohio. One flew and one did not.

Bill Stepp May 20, 2009 at 7:26 pm

Jeff writes:

Dear WSJ: You can not use a single qualitative example to generalize to a larger population. We get murdered in a thesis defense for using arguements like that.

John Steele Gordon was providing some empirical examples of Rothbard's theoretical discussion of why government can't operate like a business. See Murray N. Rothbard, "Power and Market," chap. 5.

I gather your into "econometrics."

Try this for size:

Prove the fallacy of econometrics.
1. Econometrics is mathematical history.
2. Mathematics is a priori knowledge.
.:. 3. Econometrics is a priori history.
4. A priori history is a fallacy.
.:. 5. Econometrics is a fallacy.
QED.

Jeff May 20, 2009 at 7:42 pm

QED:

My letter is directly to whomever wrote the headline that used the word 'prove'. They wrote the inappropriate headline. I like the letter and the Gordon article a lot. It's just that I do not think you can use the word prove like that.

And sadly I don't understand what econometrics is, nor this fallacy. Perhaps Dr. Roberts can do a podcast focusing on econometrics in the future.

K Ackermann May 20, 2009 at 7:44 pm

Are you saying the act of subsidizing made the work shoddy and the steamboats sink?

Here is something from Wiki about the transcontinental railroad:

"Each railroad was subsidized $16,000 per mile ($9,940/km) built over an easy grade, $32,000 per mile ($19,880/km) in the high plains, and $48,000 per mile ($29,830/km) in the mountains. To allow the railroads to raise additional money Congress provided additional assistance to the railroad companies in the form of land grants of federal lands."

What about the subsidies universities get? Does it make them worse?

The Albatross May 20, 2009 at 8:16 pm

"Each railroad was subsidized $16,000 per mile ($9,940/km) built over an easy grade, $32,000 per mile ($19,880/km) in the high plains, and $48,000 per mile ($29,830/km) in the mountains. To allow the railroads to raise additional money Congress provided additional assistance to the railroad companies in the form of land grants of federal lands."

And then they all went broke–except J. Hill's Great Northern (built without subsidies and on the most perilous route). For a rather good account of the shenanigans and shady deals regarding the transcontinental railroads, I would recommend Stephen Ambrose’s, Nothing Like it in the World: The Men Who Built the Transcontinental Railroad. As for more recent government subsidy disasters, you think we would have learned again after the recent ethanol and housing busts—we have not—but the super-duper enlightened want-to-be philosopher kings will tell us that they have it figured out this time. Here we go again.

erp May 20, 2009 at 8:31 pm

Are there any examples where government interference in commerce was successful?

The Albatross May 20, 2009 at 9:03 pm

Erp,
Sure, no one is arguing that the government cannot pick winners—they sometimes do. However, the latter is usually due to serendipity in much the same way a blind man may hit the barn door. For example, in the 1960s the Japanese government picked some winners—high technology—while simultaneously funding some real stinkers—mainly coal (the bill for the misallocation of these resources by the government came due in the early 90s). Ali Pasha's introduction of cotton to Egypt was soon followed by the U.S. Civil War. However, the British government bet the farm in the 60s on iron and steel—also stinkers. The U.S. has spent billions developing "freedom cars" since the 70s–to no avail. In post colonial Africa, all sorts of Western planners told African governments what industries to protect and coddle. Africans are still living with the resulting poverty, while a new generation of modern-day planners have arisen to make excuses for past failures. They often hold up Toyota as a star pupil of a company that thrived under government protection in much the way advocates of public education oogle magnet school while directing eyes away from the general failure of the public school system. However, Toyota’s success did not materialize until the 1960s and was a result of a tremendously unfavourable labour contract that forced Toyota to shape up or ship out—a lesson not learned by the Big Three (for a full discussion of this See The Machine that Saved the World: The Story of Lean Production). Protection destroys the firm’s incentive to innovate and become more efficient. It does not improve because it knows it cannot die, and it sticks consumers with the bill, which is why I am always perplexed why so-called “consumer advocates” spend so much time arguing against foreign competition—perhaps they are also on the payroll. Most economists have always thought the “infant industry” argument settled after so many failures, but (as always) here we go again—the ghost of Colbert reappears to haunt us with poverty.

K Ackermann May 20, 2009 at 10:04 pm

"For a rather good account of the shenanigans and shady deals regarding the transcontinental railroads…"

And therein lies the paradox.

The transcontinental wasn't built until a massive subsidy was provided. The problem is, as it is so often, that once something is subsidized, the seemingly natural way for the beneficiary to act is amorally.

Why is that? If I had contracted the same outfit and paid them the same money, should I expect the same immoral behavior?

Is it the natural state to expect that any money thrown toward an investment must be monitored very carefully, and in full daylight?

I found poetic justice in using derivatives to make a small pile of money off the banks as their market cap all but vanished toward the end of 2008. I would never hold actual stock in a bank these days simply because they owe their existence to asymmetric information.

Right now, the cost overruns alone of the various weapons systems being developed for the US military exceed the spending of the 2nd, 3rd, and 4th largest militaries combined.

Methinks May 20, 2009 at 10:15 pm

Ackerman, I would be very careful about bragging that you made money on the banks' price decline. Such unAmerican activity is under investigation at the SEC!

Banks don't owe their existence to asymmetric information any more than doctors do. Banks owe their existence to the pretty little wall built around them to protect them known as "regulation". Inside that wall, life is pretty and your political handlers will protect you from bad outcomes. Outside the wall….well, those outside the wall have to pay for the protection. Screw them.

Gil May 21, 2009 at 1:51 am

Of course, you can include the Moon Landing in the list. Yesssssss, if you plough enough resources into a project you could plonk men on a faraway rock and bring them back but what was point other to gloat to the Russians saying "we got their first"? Perhaps it could also be said for fated explorers who mostly died to find out what 'lies beyond' even though a couple of generations later people in planes could map out the same area without much cost or risk.

Christopher Renner May 21, 2009 at 5:11 am

Don B., I have to say that the first time I ever heard of Folsom, he was on one of the C-Span channels discussing the subsidies given to the Collins line with students of some sort.
It's an absolutely riveting illustration of the advantage of unsubsidized competition in satisfying consumers most effectively (and incidentally that was the only occasion I've ever found to watch C-Span for more than 30 seconds).

K Ackermann, several points.

You say,The transcontinental wasn't built until a massive subsidy was provided. The problem is, as it is so often, that once something is subsidized, the seemingly natural way for the beneficiary to act is amorally.

When writing that first sentence did you stop to think why there apparently weren't any private companies eager to build an unsubsidized railroad across the country at that time?

The answer is most likely that there wasn't sufficient demand for it from the end users in California – there weren't enough of them willing to pay a substantial premium for passenger and cargo transport across the West by rail rather than by ship via Panama or the Straits of Magellan.

30 years later there would have been demand, as the Pacific Coast states were more settled and developed, and lo and behold the Great Northern was built without subsidies then!

If you're going to say that the U.P./C.P. proved that it was technically doable, the Pennsylvania RR had to cross rugged terrain as well and did that without subsidy.

As far as the second thing you say there, what do subsidies have to do with immoral behavior? I'm not sure if you were trying to describe the free rider problem here?

Also,
Is it the natural state to expect that any money thrown toward an investment must be monitored very carefully, and in full daylight?

Yes that's a reasonable expectation, and it's done to a much greater extent by people when it's their own money being risked, and not that of the taxpayers.

Lastly, can you cite a source for your claim about that much cost overrun on the U.S. defense budget? Wikipedia gives a rough estimate of $195 billion for those 3 defense budgets combined.

K Ackermann May 21, 2009 at 5:56 am

Christopher, This Newsweek article states the following near the end of the article:

"The U.S. defense budget for 2009 is $655 billion. China's is $70 billion, Russia's is $50 billion. America's cumulative cost overruns add up to more than the total annual defense budgets of China, Russia, Britain and France combined. This smacks less of deterrence and more of mindless extravagance and waste."

I read the printed version and my mind failed me; I thought it was only the next 3 largest instead of the next 4.

Actually both are wrong. The overruns total $300 billion, and according to Wiki, the next 5 biggest countries military expendetures total $286b.

You asked, "As far as the second thing you say there, what do subsidies have to do with immoral behavior? I'm not sure if you were trying to describe the free rider problem here?"

I was thinking about the extra 250 miles of rail that was built before they got caught. I should have been clear on that. My point was, did they try and screw the government because it was the government, or would they have acted immorally with any backer?

That $300b in cost overruns, on average, is not due to honest mistakes. That's an off-the cuff judgement that I am making. It wouldn't stand up in court, but then again, I never would have contracted to the same Bozo outfits that perpetually suckle from the public tit.

K Ackermann May 21, 2009 at 5:57 am
John May 21, 2009 at 7:31 am

On the subject of defense contract overruns, I happen to work for the Military Industrial Complex.
Cost overruns are not our fault.
The problem is government micromanagement not allowing us to do our jobs.
If the customer would just sit back and say "this is what I want" and let us make it, rather than "this how you should provide for me what I want, wait, no, do it this way, wait, no…" then it would cost them much much less.

John May 21, 2009 at 8:51 am

To expand on what I said about the government buying things.
Under normal circumstances when you purchase something or ask someone to make something for you, you assume they are the professionals and let them do their job.
Not so with government. When government is the customer they dictate not only the specifications of the end product, but also the process of making it.
Doesn't matter that they don't know anything about the process, because they are government they know everything. Any changes to the process, even if the product is not affected, must go through layers and layers of approval processes.
It is the most wasteful and inefficient thing I have ever seen.

ettubloge May 21, 2009 at 9:50 am

Folsom also tells us in "Myth…" that Vanderbilt offered free food to steamship passengers. Those "Robber Barons" driving down prices to customers, providing safer passage, offering free amenities and still making a profit while competing against others granted government subsidies. No wonder "rent-seekers" helped develop anti-trust laws.

AMATI NONYMUS May 21, 2009 at 11:05 am

"
Posted by: K Ackermann | May 21, 2009 5:57:35 AM

On the subject of defense contract overruns, I happen to work for the Military Industrial Complex.
Cost overruns are not our fault.
The problem is government micromanagement not allowing us to do our jobs.
If the customer would just sit back and say "this is what I want" and let us make it, rather than "this how you should provide for me what I want, wait, no, do it this way,
"

Congress should learn to build first 4 Hubble Telescopes on Earth before they order one for orbit.

K Ackermann May 21, 2009 at 11:07 am

"Not so with government. When government is the customer they dictate not only the specifications of the end product, but also the process of making it."

John, please.

Every military contractor has a staff that interfaces with the government, and their only job is to listen for changes, and make them happen with the least pain to the company.

Other than that, the military has an unbelievably extensive procurement system, with millions of NIIN part numbers and specs/datasheets.

Plenty of latitude is given on prototypes, and yes, production is spec'd because it's military equipment and soldiers are funny about the planes they fly and guns they shoot.

$300 billion is not government meddling, unless you include kickbacks as meddling. Boeing tried it with $30 billion woth of tankers not too long ago and a few people ended up in jail, much to Rumsfeld's embarrassment. He was used to the unchecked ripoffs taking place during the Iraq war.

John May 21, 2009 at 12:08 pm

Ackermann,
I just know that in my little niche we're wasting all kinds of taxpayer dollars because of micromanagement from a clueless customer.
Do it this way… No, do it that way… Don't do anything while we make up our mind…

Trust you to come to the defense of government while pointing fingers at a particular administration (Bush! Bush! Bush!).

BTW where did all the Iraq war protesters go?
There were none. They were Bush protesters.

The problem is not which parties or individuals run the government, but the decision making process within government.
It's not logical.

K Ackermann May 21, 2009 at 1:15 pm

Bush was a mess, but do you hear me cheering on Obama?

This is the only place I seem to defend the government, which is weird because I am normally shredding it.

I just don't see any evidence that giving large corporations free reign is in the best interest. Only half of the stupid things the government does was thought up by politicians. The other half were the result of prodding from industry.

That part does not seem to be acknowledged here, so I am acknowledging it.

I can point you to some viciously critical writing about the government that I have done if you want. I don't like pimping my stuff, but if you want credentials, I can supply them.

John May 21, 2009 at 1:30 pm

Ackermann,
I'm just saying that down here in the MIC trenches I see a lot of waste due to over-participation by government fools making decisions about things they don't understand.
I'm not disputing the waste you wrote of; I'm saying that it's not always the contractor's fault.
In my work I've got government people who can barely use a computer involved in the software design process.
They are always right not only because they are the customer, but because they are government.
I haven't been allowed to do my job for a couple months because some idiot thinks that documentation will prevent all bugs, bugs that are not found because lazy government workers won't test the product.
It's stupid and wasteful.

I'm making a leap that my case is not unique, and that there is other waste due to government people micromanaging things about which they haven't a clue.

I could be wrong.

John May 21, 2009 at 1:36 pm

Not that I'm bitter or anything…

Methinks May 21, 2009 at 1:50 pm

"I just don't see any evidence that giving large corporations free reign is in the best interest."

Change "free reign" to freebies or welfare and you have my full agreement.

"Only half of the stupid things the government does was thought up by politicians. The other half were the result of prodding from industry."

Oh, you're being too generous in thinking politicians can dream so big. The vast majority of the idiocy in government is private industry dreaming up of ways for their newly purchased politicians to create rents (excess profit) for them by curtailing competition or extracting a taxpayer funded subsidy. The fact that government has the ability to create these cushy environs for their favoured special interest group is the problem. You probably haven't been reading this blog long enough to know that everybody save the more to the left and extremely stupid understand this.

There's the fallacy to which you subscribe….You believe that regulation gutting (which did not occur) caused the financial crisis. However, it is the regulators who created all the treats for the industry and more regulation just means less competition, more subsidy and more rents for them. they are organized and are very happy to pay top dollar to a politician looking to monetize his power (which is all politicians).

As long as politicians are self interested, they will monetize their power by selling it to the highest bidder. As long as they have power to sell, industry will buy it – and industry will have free reign over government.

K Ackermann May 22, 2009 at 12:03 am

@Methinks – maybe the regulations were not technically gutted, but all proposals to strengthen them were defeated. The measures that did pass specifically carved out securitization and swaps as areas where oversight was forbidden.

Voluntary oversight for bank holding companies? And they now act surprised there was no voluntary compliance on the non-regulations the financial industry insisted on policing themselves.

How can they possibly convince us they are to be trusted to operate without strict oversight? The got everything they asked for, and told us to trust them.

The politicians are the worst of the lot. They are the facilitators, and they are doing the exact opposite job that the government should be doing. The government is supposed to stay as far away from the free market as can be. Its only purpose is to handle the things the free market can't, won't, or shouldn't deal with.

Instead, the government ends up distorting the market by placing all the incentives in the wrong places. Even more infuriating is the fact that it now spends an inordinate amount of effort trying to stay one step ahead of the laws it breaks. It changes the rules to where the law is a joke now.

It seems to recognize this at some level and no longer seeks to prosecute crime except in trivial ways.

I don't know if you are familiar with the weapons offset trade, but if you ever looked into the whole vertical structure of it, it's hard not to see the government as a primary dealer in all the illicit things forbidden by the rules of decency, and the rule of law.

I figure it's only a matter of time before Cheney starts a company that harvests the organs of our "enemies" to sell on the open market.

You watch; Gitmo is going to get a private industry solution. Incarcerating people is very lucrative, and I imagine a special prison for terrorists would be quite a fish to land. We can buy terrorists on the open market like we did in Afghanistan, and then torture them in new super-efficient enhanced counciling sessions for the names of relatives that might be willing to trade blocks of cash. If not, they can donate a liver to some rich alcoholic who hasn't had his fill yet.

It's all in the name of national security, you know.

The Albatross May 22, 2009 at 1:51 am

Look John has a point,
While I am no defender of the relationship between industry and government, the peculiarities of the relationship between our own government and defense industries deserves some scholarship rather than shotgun statements. For starters, I think the best account was provided by Murray Weidenbaum in his assessment of the “so called military industrial complex”. Weidembaum discovered that it was not so much the industrial complex pushing around the military as it was the military pushing around the industrial complex. Defense contractors had to run their facilities according to the phone-book-sized Army Corps of Engineers Manuals, among other things. In fact, the defense industries had become so entrenched in government red tape and paperwork that the peace dividend meant that they had to tear down whole factories and start again. When, after the fall of the Berlin Wall, the Soviets wanted to know how they could switch tanks to fridge production, the head of Martin-Marrietta told then to blow the plant and start over. I have no love for defense contractors but they were forced into this disadvantageous position by govt and can only extract themselves by those who are good with red tape00as is firmer defense secretaries or vive presidents—aspredicted by professor Weidenbaum.

Methinks May 22, 2009 at 1:56 pm

Soviets wanted to know how they could switch tanks to fridge production

No, the Soviets wanted to know what a fridge was. :-)

Methinks May 22, 2009 at 2:10 pm

Ackerman,

We don't need to trust them. The market imposes its own discipline on firms that take too much risk. The law imposes costs for committing fraud.

You can have as much regulation as you want. People will still behave the way they want. Transactions that used to take place in well understood financial instruments and on visible public exchanges will simply move to more esoteric opaque securities trading on the completely opaque unofficial market that isn't regulated or move transactions out of the United States entirely. Firms will engage in regulatory arbitrage. Meanwhile, incentives will continue to be perverted by politicians. All regulation does is provide rents for insider firms, worsen system risk and gives smart people in the industry a reason to get creative.

The Soviet Union, where the government controlled EVERYTHING, had an enormous black market. where there's a will, there's a way. You're operating under the delusion that oversight is actually possible. It isn't and more firms don't blow up not because the regulator is overseeing them, but because they don't want to blow up their firms!

Reminds me of what Princess Leia said to Darth Vader in the original trilogy" "The more you tighten your fist, the more we squeeze through your fingers".

Christopher Renner May 22, 2009 at 9:19 pm

A day late, I know, but…

Ackerman, you (following Zakaria's lead in the earlier mentioned article) compare apples and oranges. The $300 billion in overruns cited by the GAO are cumulative, for the 95 largest weapons programs in question. The other countries' defense budgets are annual.

I'm not in the least doubting that defense programs, like any other government project, have massive cost overruns. But without knowing how long the programs have been in development it's impossible to say whether this comparison is useful for practical analysis or not.

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