The Free Market 12, no. 7 (July 1994)
Federal bureaucrats think they, not the financial markets should direct investment spending. They want to rebuild “infrastructure,” fund space stations, install magnetic supertrains, and set up information highways (or redistribute the existing ones). That’s what President Clinton means when he says he’ll “grow the economy” through “investment.”
He shouldn’t expect success, even if he merely wants to make political hay while the sun shines. American history is replete with failures of such projects. Among the first attempts of state and national to direct economic development were the Chesapeake Canal, the National Turnpike, the First Bank of the United States, and the Erie Canal. New York State began the Erie in 1817, completed it by 1826 at a cost of $8.4 million, and solidified New York City as the center of commerce and finance.
The example proved disastrous. Encouraged by its apparent success, New York State embarked on eight new canal projects at a cost of $9.4 million. These turned out to be sink holes, failing to cover even their operating costs. And the projects sparked a speculative boom in New York that eventually caused eight banks to fail. Due to the failure of these banks, the state’s guaranty fund failed. A special tax was levied to cover the cost of the canal bonds and to bail out the guaranty fund.
The people of the state of Pennsylvania wished they were so lucky. Following the example of Erie, the State of Pennsylvania began work on a composite canal, turnpike, and railway from Philadelphia to Pittsburgh. This road was completed in 1834 at a cost of $14.6 million, and was followed by construction of six more canals, costing $6.5 million. These projects failed miserably, forcing the state into default on its bonds. This fact was not so kindly noted by William Wordworth in his poem “To the Pennsylvanians.”
Maryland likewise was forced into default by the failure of its development projects. Indeed, of those states that had, prior to the 1830s, embarked on development projects, only Massachusetts avoided serious losses. This was because Massachusetts quickly ended its direct involvement, and relied instead on private enterprise.
In the 1830s, a second wave of development projects began in the frontier states of the Midwest. The apparent success of the Illinois and Michigan Canal, like that of the Erie Canal, enticed Illinois to follow up. In 1837, $10.2 million was approved for a variety of internal improvements, including 1,341 miles of railroad. In the log-rolling of this bill through the legislature, Abraham Lincoln was one of the worst pork barrelers.
After the State of Illinois spent the money, the only things produced were an enormous debt and 26 miles of railroad, known as the Northern Cross, stretching from the Illinois River to Springfield. The new taxes needed to retire this debt persuaded many pioneers to settle in Iowa and Wisconsin.
Indiana, which in 1836 had approved $10 million for canals, turnpikes, and railroads, was forced into default in 1840. Michigan didn’t do as badly. In 1837, it approved a less grand total of $5 million for internal improvements. Furthermore, the state was fortunate to recover 90% of the cost of one of its partially-completed railroads, and 43 % of the cost of another when sold to private interests.
In 1850, Missouri began yet another attempt to direct economic development. By 1856, 914 miles of railroad were built at a cost of $3 3.4 million. However, the state had to assume $31.8 million in debt because of the bankruptcy of all but one of the new railroads. The state itself defaulted in 1861. Sale of several of the bankrupt roads reduced the state’s indebtedness somewhat. NevertheIess, in 1875, Missouri adopted a constitutional amendment prohibiting the use of the credit of the state to assist any private or corporate enterprise.
One secret behind the failures of these development projects was corruption. The process by which the states awarded these projects invited bribes and graft. Once the projects were underway, there was little incentive to produce a viable project. Instead, the incentive was to maximize the difference between the funds approved and the actual cost of the project. The usual result was shoddy work, excessive awards to subcontractors, cost overruns, and incomplete projects.
This is why, when the state of Michigan sold its partially completed railroads, it not only stipulated that the railroads had to be completed, but that the parts already constructed had to be rebuilt. Out of this mess, private enterprise built the Michigan Central Railroad. Similarly, out of the composite canal-railroad-turnpike from Philadelphia to Pittsburgh, private enterprise built the Pennsylvania Railroad. Such public projects always fail, especially when considering the unseen costs and redistribution of wealth that follow in their wake. The few apparent successes have been followed up by even more enormous failures.
From deposit insurance to synfuels, from superconducting supercolliders to information highways, these projects impoverish the taxpayer and enrich well-connected corporations. They are, as the Jeffersonians first told us centuries ago, entirely illegitimate.
