Entrepreneurs and the State; B. Folsom

133 Entrepreneurs and the State by Burt Folsom T he big story in the u.s. auto industry during 1987 was the sharp growth (+ 35%) in sales for Honda and the de cline ( - 23%) for Chrysler. While Honda sold cars as fast as it could make them, Chrysler struggled with a huge backlog of 1987 models. These results should not surprise us-they are part of a long historical pattern: federally aided companies, like Chrysler with its federally guaranteed loans, rarely outperform those that have to succeed on their own merits. Those risk-takers who have sought and re ceived help from the state we will call political entrepreneurs; those who have succeeded without it we will call market entrepreneurs. In steamships and railroads, two of the largest in dustries in the U.S. during the 1800s, these two groups of entrepreneurs regularly clashed, just as they do today. Almost from the time of the first trans-At lantic voyage by steam in the 1830s, the gov ernments of England and the United States sub sidized steamship travel. Samuel Cunard, a po litical entrepreneur, convinced the English government to give him $275,000 a year to run a biweekly mail and passenger service across the Atlantic. Cunard charged $200 per pas senger and 24 cents a letter, but still said that he needed the annual aid to cover his losses. He contended that subsidized steamships gave EngBurt Folsom is Associate Professor of History at Murray State University in Kentucky. This article is adapted from his recent book, Entrepreneurs vs. the State (available from FEE @ $14.00 postpaid).

land an advantage in world trade and were a readily available merchant marine in case of war. Parliament accepted this argument and in creased government aid to the Cunard Line throughout the 1840s. Soon, Edward Collins, a political entrepre neur across the ocean, began using these same arguments for Federal aid to the new U. S. steamship industry. He said that America needed subsidized steamships to compete with England, to create jobs, and to provide a mili tary fleet in case of war. If the government would give him $3 million down and $385,000 a year, he would build five ships, deliver mail and passengers, and outrace the Cunarders from coast to coast. Congress gave this money to Collins in 1847, but he built four enormous ships (not five smaller ships as he had promised), each with elegant saloons, ladies' drawing rooms, and wedding berths. He covered the ships with plush carpet and brought aboard olive-wood furniture, marble tables, exotic mirrors, painted glass windows, and French chefs. Collins stressed luxury, not economy, and his ships used almost twice the coal of the Cunard Line.

He often beat the Cunarders across the ocean by one day, but his costs were high and his eco nomic benefits were nil. With annual government aid, Collins had no incentive to reduce his costs from year to year. He preferred to compete in the world of politics for more Federal aid than in the world of busi ness against price-cutting rivals. In 1852 he went to Washington and lavishly entertained 134 THE FREEMAN. APRIL 1988 New York Harbor in the mid-1800s. President Fillmore, his cabinet, and influential Congressmen. Collins artfully lobbied Con gress for an increase to $858,000 a year. It took Cornelius Vanderbilt, a New York shipping genius, to challenge this system. In 1855, Vanderbilt offered to deliver the mail for less than half of what Collins was getting. Con gress balked-it was pledged to Collins-so Vanderbilt decided to challenge Collins even without a subsidy. "The share of prosperity which has fallen to my lot," said Vanderbilt, "is the direct result of unfettered trade, and un restrained competition. It is my wish that those who are to come after me shall have the same field open before them."

Vanderbilt's strategy against Collins was to cut the standard first-class fare to $80. He also introduced a cheaper third-class fare in the steerage. The steerage must have been uncom fortable-people were practically stacked on top of each other-but for $75, and sometimes less, he did get newcomers to travel. Vanderbilt also had little or no insurance on his fleet: he built his ships well, hired excellent captains, and saved money on repairs and insurance. Finally, Vanderbilt hired local "runners" who buttonholed all kinds of people to travel on his ships. These second-and third class passengers were important because all steamship operators had fixed costs for each voyage. They had to pay a set amount for coal, crew, maintenance, food, and docking fees. In such a situation, Vanderbilt needed volume business and sometimes carried over 500 pas sengers per ship. All this was too much for Collins. When he tried to counter with more speed, he crashed two of his four ships, killing almost 500 pas sengers. In desperation he spent one million dollars of government money building a gi gantic replacement, but he built it so poorly that it could make only two trips and had to be sold at more than a $900,000 loss.

Finally, Congress was outraged. Senator Robert M. T. Hunter of Virginia said: "The whole system was wrong . . . it ought to have been left, like any other trade, to competition." Senator John B. Thompson of Kentucky con curred: "Give neither this line, nor any other line, a subsidy. . . . Let the Collins Line die. . . . I want a tabula rasa-the whole thing wiped out, and a new beginning." Congress voted for this "new beginning" in 1858: they revoked Collins' aid and left him to compete with Vanderbilt on an equal basis. The results: Collins quickly went bankrupt, and Vanderbilt became the leading American steamship oper ator. And there was yet another twist. When Van derbilt competed against the English, his major competition did not come from the Cunarders. The new unsubsidized William Inman Line was doing to Cunard in England what Vanderbilt had done to Collins in America. The subsidized Cunard had cautiously stuck with traditional technology, while William Inman had gone on to use screw propellers and iron hulls instead of paddle wheels and wood. Inman's strategy worked; and from 1858 to the Civil War, two market entrepreneurs, Vanderbilt and Inman, led America and England in cheap mail and passenger service. The mail subsidies, then, ended up retarding progress: Cunard and Collins both used their monopolies to stifle in novation and delay technological changes in steamship construction.

Unfortunately, this cycle of government sub sidy, mismanagement, and bankruptcy repeated itself a few years later in the railroad industry. With California and the Rocky Mountains safely in the Union, some people wanted a transcontinental railroad to tie the country to gether. Political entrepreneurs of the day con vinced Congress that without Federal aid the nation could not be linked by rail. Most histo rians have bought this argument, too. The late Thomas Bailey, whose textbook, The American Pageant, has sold over two million copies, said, "Transcontinental railroad building was so costly and risky as to require government subsidies. " Congress adopted this logic and gave almost 100 million acres and $61 million in Federal loans to four transcontinentals. With massive Federal aid came unprecen dented corruption. The Union Pacific and Cen tral Pacific built shoddy lines very quickly just to capture the Federal subsidies. Also, the Credit Mobilier scandal, in which Union Pa cific officials bribed Congressmen with cheap stock in return for favorable votes, rocked the Grant administration and branded the whole ENTREPRENEURS AND THE STATE 135 James J. Hill railroad industry as corrupt. Eventually, nega tive public reaction helped lead to the establish ment of the Interstate Commerce Commission.

Congress, in effect, said that Federal regulation was the solution to the problems created by Federal aid. Fortunately, James J. Hill, a market entre preneur, showed the country how to build a different kind of transcontinental. From 1879 to 1893 he built the Great Northern Railroad from St. Paul to Seattle with no Federal subsidy. Slowly, methodically, and with the best tech nology of his day he built a model line-rela tively straight, on an even grade, and with high quality steel. He made each piece pay for itself before he moved further west. During the de pression of the 1890s, when the subsidized Union Pacific, Northern Pacific, and Santa Fe Railroads went bankrupt, Hill ran his line prof itably each year. State aid-and this includes tariffs as well as loans-is always well intentioned. From Collins to Iacocca those who seek such aid really believe they have their nation's best in terest at heart: they are protecting jobs, helping local industries compete, and preserving the in dustrial future of the nation. It is sad to see the opposite so often happen. Chrysler did pay back its loans-but it appears to be following the historical pattern set long ago in steamships and railroads. D 136 The Myth of Japanese Industrial Policy by C. Brandon Crocker R ecord trade deficits and the fear that America is losing its manufacturing base have focused attention on the need to restore American competitiveness. One pro posed solution, which is making its way toward the political front burner, is "industrial policy' ,- government intervention in specific sectors of the economy geared toward "im proving the patterns of our investments.' ,1 This idea last came to the fore when Walter Mondale adopted it in his 1984 presidential bid. Although the term "industrial policy" is somewhat vague, and is used to mean different things by different people, it usually encom passes some form of government intervention aimed at specific industries. Such intervention ranges from subsidies or tax breaks to govern ment-financed employee training programs.