Organized Crime

The late nineteenth century is often referred to as the time of the “robber barons.” It is a staple of history books to attach this derogatory phrase to such figures as John D. Rockefeller, Cornelius Vanderbilt, and the nineteenth-century railroad operators such as Grenville Dodge, Leland Stanford, Henry Villard, James J. Hill, and others. To most historians writing on this period, these entrepreneurs committed thinly veiled acts of larceny to enrich themselves at the expense of their customers. Once again we see the image of the greedy, exploitative capitalist, but in many cases this is a distortion of history.

As common as it is to speak of “robber barons,” most who use that term are confused about the role of capitalism in the American economy and fail to make an important distinction—the distinction between what might be called a market entrepreneur and a political entrepreneur. A pure market entrepreneur, or capitalist, succeeds financially by selling a newer, better, and/or less expensive product on the free market without any government subsidies, direct or indirect. The key to his success as a capitalist is his ability to please the consumer, for in a capitalist society the consumer ultimately calls the economic shots. By contrast, a political entrepreneur succeeds primarily by influencing government to subsidize his business or industry, or to enact legislation or regulation that harms his competitors.

The American economy has always included a mix of market and political entrepreneurs—self-made men and women as well as political connivers and manipulators. Sometimes people who have achieved success at one point in their lives through market entrepreneurship become political entrepreneurs at another point in their lives. Market entrepreneurship is a hallmark of capitalism, whereas political entrepreneurship is not. It is using the state’s coercive powers to plunder one’s customers and competitors. It is a form of “mercantilism,” the very type of political system that Adam Smith criticized in his famous 1776 book, An Inquiry into the Nature and Causes of the Wealth of Nations.

Railroading versus Being Railroaded

Most business historians have assumed that the transcontinental railroads would never have been built without government subsidies. The free market would have failed to provide the adequate capital, or so the theory asserts. The evidence for this theory is that the Union Pacific and Central Pacific railroads, which were completed in the years after the War Between the States, received per-mile subsidies from the federal government in the form of low-interest loans as well as massive land grants. But there need not be cause and effect here: the subsidies were not needed to cause the transcontinental railroads to be built. We know this because, just as many roads and canals were privately financed in the early nineteenth century, a market entrepreneur named James J. Hill built his own privately-financed transcontinental railroad, The Great Northern. Hill boasted that he built The Great Northern without any government subsidy, not even the right of way through public lands. He paid cash for the right of way of his railroad, even through Indian lands.

Hill strongly opposed government favors being granted to his competitors. In James J. Hill and the Opening of the Northwest, biographer Albro Martin quoted Hill as saying, “The government should not furnish capital to these companies, in addition to their enormous land subsidies, to enable them to conduct their business in competition with enterprises that have received no aid from the public treasury.”

James J. Hill was no “baron” or aristocrat. His father died when he was fourteen so he dropped out of school to work in a grocery store for four dollars a month to help support his widowed mother and his siblings. As a young adult he worked in the farming, shipping, steamship, fur-trading, and railroad businesses. He learned the ways of business in these settings, saved his money and eventually became an investor and manager of his own enterprises.

Hill got his start in the railroad business when he and several partners purchased a bankrupted Minnesota railroad that had been run into the ground by the government-subsidized Northern Pacific (NP). The NP had been a patronage “reward” to bankster Jay Cooke, who in the War Between the States had been one of the U.S. government’s leading financiers. But Cooke and his NP associates built their railroad recklessly; the government’s subsidies and land grants were issued on a per-mile-of-track basis, so Cooke and his cohorts had financial incentives to build as quickly as possible, which only encouraged shoddy work. Consequently, by 1873 the NP had fallen into bankruptcy. The people of Minnesota and the Dakotas, where the railroad was being built, considered Cooke and his associates to be “derelicts at best and thieves at worst,” according to historian Michael Malone, author of James J. Hill: Empire Builder of the Northwest.

It took Hill and his partners five years to complete the purchase of the railroad (the St. Paul, Minneapolis, and Manitoba), which would form the nucleus of a railroad that he would eventually build all the way to the Pacific Ocean. He had nothing but contempt for Cooke and the NP for their shady business practices and their corruption and quickly demonstrated a genius for railroad construction. Under Hill’s direction the workers began laying rails twice as quickly as the NP crews had done, and even at that speed he built what everyone at the time considered to be the highest-quality line. He was a meticulous cost cutter and his cost reductions were passed onto his customers in the form of lower rates. Hill understood that the farmers, miners, timber interests, and others who patronized his railroad would either succeed or fail along with him. His motto was, “We have got to prosper with you or we have got to be poor with you.”

In keeping with this philosophy Hill encouraged crop diversification among the farmers along his route, educating them on the economic dangers of being dependent on a single crop. He provided free seed grain and even cattle to farmers who had suffered from drought and depression. He transported immigrants to the Great Plains for a mere ten dollars if they promised to farm near his railroad, and he donated land to towns for parks, schools, and churches.

Hill’s rates fell steadily, year after year, and when farmers began complaining about the lack of grain storage space near his railroad line he instructed his company managers to build larger grain storage facilities. He refused to participate in price-fixing conspiracies with other railroad owners, and reveled in “the role of rate-slasher and disrupter of [such] pooling agreements,” wrote Burton Folsom in Entrepreneurs versus the State.

Folsom describes Hill’s compulsion for excellence in the following way:

Hill’s quest for short routes, low grades, and few curvatures was an obsession. In 1889, Hill conquered the Rocky Mountains by finding the legendary Marias Pass. Lewis and Clark had described a low pass through the Rockies back in 1805; but later no one seemed to know whether it really existed or, if it did, where it was. Hill wanted the best gradient so much that he hired a man to spend months searching western Montana for this legendary pass. He did in fact find it, and the ecstatic Hill shortened his route by almost one hundred miles.

Because of such behavior, historian Michael Malone wrote that The Great Northern was “the best constructed and most profitable of all the world’s major railroads.”

In sharp contrast, the government-subsidized transcontinental railroads were a carnival of corruption and inefficiency. For each mile of track, the government gave the Union Pacific (UP) and Central Pacific (CP) railroads, which it had created, land grants as well as below market rate subsidized loans of $16,000 per mile for track built on flat land; $32,000 for hilly terrain; and $48,000 in the mountains. Consequently, the UP and CP built winding, circuitous routes in order to pocket more and more subsidies. According to Burton Folsom, they stressed speed and not workmanship and always used the cheapest building materials. They were so corrupt and inefficient, Folsom wrote, that they built tracks on several feet of ice and snow and “Naturally, the line had to be rebuilt in the spring.”

Instead of spending their time brainstorming for ways to cut costs, shorten routes, and encourage economic prosperity alongside their rail lines, the executives of the UP and CP were more likely to wine and dine politicians and bureaucrats with grandiose gourmet dinners on train cars that often included a buffalo hunt from the train after dinner.

Many members of Congress demanded separate rail lines to their congressional districts as a condition of voting for the subsidies, resulting in a map of the UP and CP routes looking like a bowl of spaghetti. Moreover, because regulations always accompany any government subsidies to businesses, the UP and CP managers could not make any significant business decisions without the direct interference by the U.S. Congress. The result was gross economic inefficiency, corruption, and bankruptcy.

Hill continued to cut his rates for decades, and excelled at offering volume discounts to his largest customers. The less efficient, government-subsidized railroads hated him for this, for Hill’s price cutting exposed their inefficiency and incompetence. The government got its revenge for Hill’s price cutting with the Interstate Commerce Act of 1887 that banned “rate discrimination” such as volume discounts, and was followed by the Hepburn Act of 1906 which explicitly made it illegal to charge different rates to different customers. They banned price cutting, in other words, by forcing everyone to charge the same higher rates. Since Hill and his customers were the biggest beneficiaries of the Great Northern’s price cutting, they were the biggest losers from this legislation.

There was no “robbery” on the free market in the late nineteenth/early twentieth century railroad business. The real crooks were the operators of the government-subsidized railroads and their political patrons in the Congress and the executive branch of government.