“We’re the country that built the intercontinental railroad,” Obama says. “So how can we now sit back and let China build the best railroads?”

I guess Obama doesn’t know that the transcontinental railroad was a Solyndra-like Big Government scandal. The railroad didn’t make economic sense at the time, so the government subsidized construction and gave the companies huge quantities of the best land on the continent. As we should expect, without market discipline—profit and loss—contractors ripped off the taxpayers. After all, if you get paid by the amount of track you lay, you’ll lay more track than necessary.

Crédit Mobilier, the first rail construction company, made enormous profits by overcharging for its work. To keep the subsidies flowing it made big contributions to congressmen.

Where have we heard that recently?

The transcontinental railroad lost tons of money. The government never covered its costs, and most rail lines that used the tracks went bankrupt or continued to be subsidized by taxpayers. The Union Pacific and Northern Pacific—all those rail lines we learned about in history class—milked the taxpayer and then went broke.

One line worked. The Great Northern never went bankrupt. It was the railroad that got no subsidies.

We need infrastructure, but the beauty of leaving most of these things to the private sector—without subsidies, bailouts, and other privileges—is that they would have to be justified by the profit-and-loss test. In a truly free market, when private companies make bad choices, investors lose their own money. This tends to make them careful.

By contrast when government loses money, it just spends more and raises your taxes, or borrows more, or inflates. Building giant government projects is no way to create jobs. When government spends on infrastructure, it takes money away from projects that consumers might think are more important. When government isn’t killing jobs by sucking money out of the private sector, it kills jobs by smothering the private sector with regulation. I talked to Peter Schiff about all this. Schiff is a good authority because he was one of the few people to warn of the housing bust. Now he’s had a run-in with the federal government over job creation.

Schiff, who operates a brokerage firm with 150 employees, recently complained to Congress that “regulations are running up the cost of doing business, and a lot of companies never even get started because they can’t overcome that regulatory hurdle.”

Schiff claims he would have hired a thousand more people but for regulations.

“I had a huge plan to expand. I wanted to open up a lot of offices. I had some capital to do it. I had investors lined up. My business was doing really well. But unfortunately, because of the regulations in the securities industry, I was not able to hire.”

People don’t appreciate the number of regulations entrepreneurs face. Schiff pays ten people just to try to figure out if his company is obeying the rules.

“Even my brokers . . . find out that maybe 20 percent, 30 percent of their day is involved in compliance-related activity, activity that is inhibiting their productivity. . . . All around the country, people are complying with regulations instead of producing, instead of investing and growing the economy. They’re trying to survive the regulations,” he said.

This is no way to create jobs or wealth. Keynesian pundits and politicians can’t understand why businesses sit on cash rather than invest and hire unemployed workers. It’s really no mystery. Government is in the way.

Few historians, however, describe the costs of the war. Not just the 620,000 individuals who died, or the devastation to southern states, but the economic costs of waging total war. What was the economic impact of the Civil War on American life?

The first and most important point is that the Civil War was expensive. In 1860 the U.S. national debt was $65 million. To put that in perspective, the national debt in 1789, the year George Washington took office, was $77 million. In other words, from 1789 to 1860, the United States spanned the continent, fought two major wars, and began its industrial growth—all the while reducing its national debt.

We had limited government, few federal expenses, and low taxes. In 1860, on the eve of war, almost all federal revenue derived from the tariff. We had no income tax, no estate tax, and no excise taxes. Even the hated whiskey tax was gone. We had seemingly fulfilled Thomas Jefferson’s vision: “What farmer, what mechanic, what laborer ever sees a tax-gatherer of the United States?”

Four years of civil war changed all that forever. In 1865 the national debt stood at $2.7 billion. Just the annual interest on that debt was more than twice our entire national budget in 1860. In fact, that Civil War debt is almost twice what the federal government spent before 1860.

What’s worse, Jefferson’s vision had become a nightmare. The United States had a progressive income tax, an estate tax, and excise taxes as well. The revenue department had greatly expanded, and tax-gatherers were a big part of the federal bureaucracy.

Furthermore, our currency was tainted. The Union government had issued more than $430 million in paper money (greenbacks) and demanded it be legal tender for all debts. No gold backed the notes.

The military side of the Civil War ended when Generals Ulysses S. Grant and Robert E. Lee shook hands at Appomattox Court House. But the economic side of the war endured for generations. The change is seen in the annual budgets before and after the war. The 1860 federal budget was $63 million, but after the war, annual budgets regularly exceeded $300 million. Why the sharp increase?

First, the aftermath of war was expensive. Reconstruction governments brought bureaucrats to the South to spend money on reunion. More than that, federal pensions to Union veterans became by far the largest item in the federal budget (except for the interest payment on the Civil War debt itself). Pensions are part of the costs of war, but the payments are imposed on future generations. In the case of the Civil War, veterans received pensions only if they sustained injuries severe enough to keep them from holding a job. Also, widows received pensions if they remained unmarried, as did their children until they became adults. Confederates, of course, received no federal pensions.

Pensions and Tensions

The Civil War pensions shaped political life in America for the rest of the century. First, northern states benefited from pension dollars at the expense of southern states. That kept sectional tensions high. Second, Republicans “waved the bloody shirt” and blamed Democrats for the war. Republican presidents had incentives to keep the pension system strong, and the Grand Army of the Republic (GAR) lobbied to get as much money for veterans as possible.

The federal government established pension boards to determine whether injuries to veterans warranted a pension. But the issue was complex. Sometimes, veterans created or faked injuries; others argued that injuries received after the war—for example, falling off of a ladder while fixing a roof—were really war injuries. If the pension board turned down an application, the veteran sometimes pleaded to his congressman—who was often able to get a special pension for his constituent through Congress. The corrupt pension system corroded politics for the whole 1865-1900 period.

President Grover Cleveland tried to stop congressmen from voting pensions to constituents with bogus injuries by vetoing bill after bill. His successor, Benjamin Harrison, “solved” the problem by signing the Blair bill, which liberalized pensions to the point that even old age made a veteran eligible for a pension. During the 1890s, after most veterans had died, pension payments remained a huge and corrupting item in the federal budget.

The economic impact of the Civil War extended beyond pensions. One argument made during the war was that transportation needed to be improved to connect California with the other Union states. President Lincoln signed a bill establishing federal subsidies for building two transcontinental railroads.

Lincoln was a gifted writer and an able defender of natural rights, but on railroad subsidies he had a reverse Midas touch. During the 1830s, for example, when Lincoln was in the Illinois legislature, he helped lead the charge for a $12 million subsidy to bring railroads to the major cities of Illinois. Unfortunately for Lincoln, the money was wasted and the railroads largely went unbuilt. According to William Herndon, Lincoln’s law partner, “[T]he internal improvement system, the adoption of which Lincoln had played such a prominent part, had collapsed, with the result that Illinois was left with an enormous debt and an empty treasury.”

Bribes Across America

When Lincoln signed the transcontinental railroad bill in 1862, he was creating an even larger boondoggle. The Union Pacific and Central Pacific Railroads were to be paid by the mile to lay track from Omaha to Sacramento. Thus, the UP and CP had incentives to create mileage, but not quality mileage. Their railroads were sometimes not straight, and other times went over hilly terrain that was impossible for a train to surmount. When finished, parts of what they had built were unusable, but both lines had paid off politicians (with some of their subsidy money) to continue the subsidies and not inquire closely on how they were being spent.

Lincoln is not responsible for the corruption that occurred after he died, but the Republican leaders during the war committed themselves to many federal interventions other than the constructive one of ending slavery. The National Banking Act of 1863, and amendments to it, brought greater federal control to banking and imposed a 10 percent tax on state bank notes.

The Morrill Act of 1862 gave 17.4 million acres of federal land to states to build land-grant colleges to teach citizens agriculture and science. Gifts of land and statements of educational focus seem like minor interventions, but the Constitution gave no role to the federal government in subsidizing education or creating universities. The Morrill Act became an entering wedge for later interventions (the Hatch Act of 1887 and the Smith Lever Act of 1914) that established direct federal subsidies to those same land-grant colleges.

Once the federal government intervenes in an area, it’s hard to remove the controls and easy to expand them. The Gilded Age generation did, however, halt some of those Civil War interventions. Those moves back to freer markets in the late 1800s help account for the tremendous economic growth during that time.

Some Rollbacks

The starting point here is the decision after the Civil War to reduce the $2.7 billion national debt. From 1866 to 1893, the U.S. government had budget surpluses each year and slashed the national debt to $961 million. Annual revenue during these years was about $350 million and expenses were about $270 million—most of which consisted of Civil War pensions and interest on the national debt.

One reason the federal budgets tended to be lower in the 1880s than in the 1860s and 1870s was that interest payments on the debt declined sharply as the debt disappeared. For example, the annual interest on the national debt dropped from $146 million in 1866 to only $23 million in 1893. The generation that fought the Civil War became the politicians of the Gilded Age, and they had the fortitude to wipe out almost two-thirds of the Civil War debt.

Speaking of Civil War politicians, those in the Grant administration—long maligned by historians—established many of the conditions for the freedom and prosperity of the Gilded Age. For example, Grant helped make sure the U.S. government had budget surpluses by winning $15.5 million from Britain for damages done to Union ships by the Alabama and other ships the British built for the Confederates. In 1875 Grant also signed the Specie Resumption Act, which promised to redeem the Civil War greenbacks for gold. Grant committed the United States to a sound currency and fiscal restraint.

Also under Grant, the income and estate taxes were abolished in 1872. He committed the U.S. government to budget surpluses with revenue almost exclusively drawn from tariff duties and excise taxes on alcohol and tobacco. Even before Grant was able to abolish the income tax, he had it changed from a progressive to a flat tax.

The income tax during the Civil War—the first in U.S. history—was not onerous by today’s standards. Early in the Civil War, Congress passed a flat 3 percent tax on all income over $800 (which was much more than most families earned). Then Congress made the tax progressive and raised the top marginal rate to 10 percent.

When Grant had the income tax abolished, he returned the nation to the tax system envisioned by the Founders. In Federalist 21, for example, Alexander Hamilton defended a system of consumption taxes (tariffs and excises) against income taxes—which can be more divisive and more easily manipulated by politicians. Under consumption taxes, Hamilton argued, “The amount to be contributed by each citizen will in a degree be at his own option, and can be regulated by an attention to his resources.”

Hamilton added, “If duties are too high, they lessen the consumption. . . . This forms a complete barrier against any material oppression of the citizens by taxes of this class, and is itself a natural limitation of the power of imposing them.”

After the Civil War, Americans chose to consume alcohol and tobacco in sufficient quantities to help pay down the debt each year for most of the rest of the century. American industry recovered under such limited government, and the Civil War generation paved the way for economic greatness. They overcame much of the financial damage from the Civil War.

Thus far the typical libertarian response to the growing clamor has been to challenge the science behind it. Now it really is the scientific consensus that global warming occurred during the twentieth century. What is not so obvious is that (1) humans caused this warming and (2) this warming is necessarily bad.

Although it is interesting to explore the question of whether science has been perverted in the cause of environmentalism, there is a danger for libertarians in pinning their entire case on this strategy. After all, every serious student of science knows that when it comes to empirical claims, we never achieve certainty. For example, even if today one thinks that there are insurmountable problems facing the theory of manmade global warming, one still must accept the possibility that new evidence or theoretical advances could indicate that the environmentalists are perfectly right. Another possibility is that there is some other, similar disaster lurking unsuspected.

For these reasons, I believe it is crucial to accept provisionally, for the sake of argument, the scientific claims behind the case for manmade global warming. In the present article I will demonstrate that it still would not follow that the taxes and other regulations typically proposed by greens are the best way to address the problem. Just as the free market is still the optimal economic arrangement, regardless of how many citizens are angels or devils, so too does the free market outperform government intervention, regardless of the fragility of Earth’s ecosystems.

When trying to determine if the free market is to blame for possibly dangerous carbon emissions, a logical starting point is to list the numerous ways that government policies encourage the very activities that Al Gore and his friends want us to curtail.

The U.S. government has subsidized many activities that burn carbon: it has seized land through eminent domain to build highways, funded rural electrification projects, and fought wars to ensure Americans’ access to oil. After World War II it played a key role in the mass exodus of the middle class from urban centers to the suburbs, chiefly through encouraging mortgage lending.

Every American schoolchild has heard of the bold transcontinental railroad (finished with great ceremony at Promontory Summit, Utah) promoted by the federal government. Historian Burt Folsom explains that due to the construction contracts, the incentive was to lay as much track as possible between points A and B—hardly an approach to economize on carbon emissions from the wood- and coal-burning locomotives. For a more recent example, consider John F. Kennedy’s visionary moon shot. I’m no engineer, but I’ve seen the takeoffs of the Apollo spacecraft and think it’s quite likely that the free market’s use of those resources would have involved far lower CO2 emissions. While myriad government policies have thus encouraged carbon emissions, at the same time the government has restricted activities that would have reduced them. For example, there would probably be far more reliance on nuclear power were it not for the overblown regulations of this energy source. For a different example, imagine the reduction in emissions if the government would merely allow market-clearing pricing for the nation’s major roads, thereby eliminating traffic jams! The pollution from vehicles in major urban areas could be drastically cut overnight if the government set tolls to whatever the market could bear—or better yet, sold bridges and highways to private owners.

Of course, there is no way to determine just what the energy landscape in America would look like if these interventions had not occurred. Yet it is entirely possible that on net, with a freer market economy, in the past we would have burned less fossil fuel and today we would be more energy efficient.

Even if it were true that reliance on the free-enterprise system makes it difficult to curtail activities that contribute to global warming, still the undeniable advantages of unfettered markets would allow humans to deal with climate change more easily. For example, the financial industry, by creating new securities and derivative markets, could crystallize the “dispersed knowledge” that many different experts held in order to coordinate and mobilize mankind’s total response to global warming. For instance, weather futures can serve to spread the risk of bad weather beyond the local area affected. Perhaps there could arise a market betting on the areas most likely to be permanently flooded. That may seem ghoulish, but by betting on their own area, inhabitants could offset the cost of relocating should the flooding occur. Creative entrepreneurs, left free to innovate, will generate a wealth of alternative energy sources. (State intervention, of course, tends to stifle innovations that threaten the continued dominance of currently powerful special interests, such as oil companies—for example, the state of North Carolina recently fined Bob Teixeira for running his car on soybean oil.)

Private insurers have a strong incentive to assess the potential effects of global warming without bias in order to price their policies optimally—if they overestimate the risk, they will lose business to lower-priced rivals; if they are too sanguine about the dangers, they will lose money once the claims start rolling in. Individuals finding their homes or businesses threatened by rising sea levels will find it easier to relocate to the extent that unfettered markets have made them wealthier. Industrial manufacturers, as long as they are held liable for the negative environmental effects of their production processes—a traditional common-law liability from which state policies intended to “promote industry” have often sought to shield manufacturers—will strive to develop technologies that minimize the environmental impact of their activities without sacrificing efficiency. Government interventions and “five-year plans,” even when they are sincere attempts to protect the environment rather than disguised schemes to benefit some powerful lobby, lack the profit incentive and are protected from the competitive pressures that drive private actors to seek an optimal cost-benefit tradeoff.

If the situation truly becomes dire, it will be free-market capitalism that allows humans to develop techniques for sucking massive amounts of carbon out of the atmosphere, and to colonize the oceans and outer space. Beyond these futuristic possibilities, the obvious responses to global warming—such as more houses with AC, sturdier sea walls, and better equipment to evacuate flooded regions—are again only feasible when the free market is unleashed.

It is the poorest people and nations that stand to suffer the most if the worst-case scenario for global warming is realized, and the only reliable way to alleviate their poverty, and thus help protect them from those effects, is the free market.

Can the Market Meet the Threat Head-On?

In the first section I summarized some of the ways governments inadvertently contribute to the very activities that allegedly cause dangerous global warming; in the second I sketched some of the ways that free markets allow humans to better adapt to climate change. However, I haven’t really tackled the problem directly. Am I conceding that with a worldwide problem the market—which is just dandy for one-on-one interactions—can’t match the concerted “will of the people” working through their elected representatives for a common solution?

Of course not. Even when economic transactions generate so-called negative externalities (activities that shower harms on third parties), I still contend that the free market is the best institution for identifying and reducing the problems.

One way negative externalities can be addressed without turning to state coercion is public censure of individuals or groups widely perceived to be flouting core moral principles or trampling the common good, even if their actions are not technically illegal. Large, private companies and prominent, wealthy individuals are generally quite sensitive to public pressure campaigns.

To cite just one recent, significant example, Temple Grandin, a notable advocate for the humane treatment of livestock, asserts that McDonald’s is the world leader in improving slaughterhouse conditions. While many executives at the fast-food giant genuinely may be concerned with the welfare of cattle, pigs, and chickens, undoubtedly a strong element of self-interest is also at work here, as the company realizes that corporate image affects consumers’ buying decisions.

But that self-interest does not negate the laudable outcome of the pressure McDonald’s has applied to its suppliers to meet the stringent standards it has set for animal-handling facilities. Similarly, to the degree that the broad public regards manmade global warming as a serious problem, companies will strive to be seen as “good corporate citizens” that are addressing the matter. And this isn’t ivory-tower speculation on my part—I can see the “green friendly” ads already.

Critics of libertarianism sometimes denigrate it as a political program of “market fundamentalism” that, if put into practice, would reduce all human values to the price they can fetch as mere commodities. But that is a caricature of the social arrangements advocated by any sensible libertarian. The great figures of classical-liberal and libertarian thought have always recognized the vital contributions that nonmarket institutions, such as churches, families, charities, social clubs, communities of scholars and their students, art foundations, conservation groups, neighborhood associations, and youth athletic leagues, make to the healthy functioning of a free society. What libertarians offer as an alternative to statism is not a social order that judges every human interaction solely on a miserly calculation of profit or loss, but a society in which every desirable form of voluntary association is allowed to flourish, free from coercive interference by the state.

Customary Law

Besides the samples listed above, most libertarians recognize private or customary law as another important, nonmarket source of social order. A historical case in point is the Anglo-American common-law tradition in which legal norms evolved spontaneously from the customs of the people to whom it applied, rather than through legislation and state planning deliberately aimed at achieving some “public good.” The many centuries during which the common law sustained civic order in the face of inevitable divergences between individual citizens’ own interests demonstrate that a successful legal order does not inevitably require state sponsorship. The common law has shown itself to be fully capable of dealing with a number of issues that, while not exhibiting the worldwide scope of global warming, are still similar to our present concern in arising from the cumulative effects of many individual actions, each of which, regarded in isolation, appears to be unproblematic and not subject to legal sanction. For instance, the salmon-fishing streams of Scotland are a valuable natural resource, and the communities along them have developed quite successful institutions for ensuring the value of the streams is maintained, including private policing and legal penalties for overfishing and for polluting the water.

The many cases in which voluntary solutions to problems of collective choice have worked pose an empirical embarrassment for those who argue that “public goods” must be provided by the government. Most advocates of compulsory solutions to pollution abatement, for example, would assert that voluntary efforts will be vitiated by “free riding.” If individuals are not forced to contribute their fair share toward addressing these problems, this argument runs, each person rationally will hold back and hope others will pay for the proposed solution, since any free riders would gain the benefits (such as clean air) anyway. Since almost no one likes to be “the sucker,” it follows that the amount of resources devoted to the provision of the public good will fall woefully shy of the total that would be available if each person gave the amount he’d be willing to give if only he could count on everyone else pitching in equally. The sole solution that can be imagined is for the members of a society to create a “social contract” by which they are forced to pay for pollution abatement.

However, Anthony de Jasay notes in his book The State that this argument is severely flawed. If people cannot solve public-goods problems through voluntary cooperation, how can they rely on politicians’ promises to do so? There is no external authority to enforce those promises. There is only public opinion, the same thing that would enforce voluntary solutions. Moreover, government is itself a “public good” in the sense that free riders benefit from the efforts of those who try to get the government to produce public goods such as clean air.

Is Temperature a Public Good?

Another consideration is that the earth’s temperature isn’t such a public good after all. That is, certain people really do have more at stake, particularly if the warming is moderate. For example, if Manhattan became submerged because of rising sea levels, that calamity would not affect every human being equally. The residents of Manhattan and the owners of its skyscrapers would be hurt far more than people living in inland China. Because all the various potential dangers of global warming affect particular people more intensively than others, it is these groups that (in a free market) would have the incentive to reduce CO2 concentrations. For example, if rising sea levels would cause $10 trillion in damage to a comparatively small group of wealthy individuals, that’s a huge “pie” that the wealthy can offer others to motivate them to reduce emissions.

Despite my optimism about the potential to deal with environmental problems through voluntary means, I don’t wish to be misunderstood: If the official global-warming story is true, it presents a serious problem that humanity will find difficult to solve through voluntary means. But this isn’t a strike against voluntarism—of course a difficult problem will be difficult to solve! By the very same token, the government doesn’t do a terrible job at collecting stray dogs, because that’s a very simple task. When it comes to harder assignments, such as stopping terrorism or reducing teen pregnancy, the government’s record is quite a bit worse.

The very features of the official global-warming scenario that hamper purely private solutions would apply equally to government efforts. For example, even if the U.S. government passed draconian measures at home, that alone wouldn’t be enough if China and India don’t follow suit. And just as private companies in a free market may have an incentive to pollute if they can get away with it, so the state, under the influence of special-interest groups and run by leaders always tempted to ignore the public good in favor of increasing their own power and wealth, can have incentives to allow more pollution than is optimal. (It should be clear the “best” amount of pollution is not zero, because even using fire to cook generates some pollutants, and I doubt that anyone but the most misanthropic, fanatical nature worshippers want to reverse all of the last 40,000 years of human progress.)

As in all debates over public versus private choice, it’s inappropriate to measure a realistic free-market response to global warming against an idealized government program. We must try to envision what real people would do if their property rights were respected and compare that scenario with the probable outcome of actual politicians in today’s world being given a blank check in the name of saving the earth.

Government programs don’t ameliorate world poverty or sickness, and no libertarian would deny that these are serious problems. So even if manmade global warming is a real threat, why should we expect governments to get it right on this issue?

Not long ago the television show Silicon Spin glumly reviewed the latest news of the cellular phone industry. The guests concluded that even if tech stocks, especially telecoms, had hit bottom, it would be 2003 before the experts thought the majority of them could again struggle back to profitability. Virtually all the problems, they concluded, stemmed from the industry’s rapid advance into broadband at a time that the market did not yet exist.

On the heels of the Silicon Spin analysis, the Wall Street Journal, focusing on a pair of telecoms called Qwest and Level 3 Communications, came to a similar judgment. The Web was “overbuilt,” resulting in a “fiber glut” that “underlies much of the uncertainty plaguing the telecom sector.”¹ Claiming that only 2.6 percent of the capacity was actually in use, the Journal bleakly concluded that “much of [the fiber] may remain dark forever.”

What was interesting in both the Journal and the Silicon Spin analyses was the comparison with the railroads in the nineteenth century and the argument that both the Web and the railroads were “built ahead of demand.” It behooves investors—let alone anyone concerned with the future of high-tech America—to learn if telecoms indeed do have a similar historical pattern to that of the railroads, and if so, how they also differ.

America’s first railroad construction came through private financing, although it didn’t take long before the state governments got involved. Economic historians have argued that the capital demands of the railroads dwarfed those of any other industry. While that might have been true in the 1850s, it was not the case in the 1830s or 1840s. Founders of many early roads had simple objectives, often merely linking a single city to a river, or even building a shortcut between a long and difficult bend in a single river, as was the case in Alabama.

After the canal craze of the 1830s, in which many state governments subsidized construction by guaranteeing the canal companies’ bonds, the precedent was set for the states to support railroads. A number did so enthusiastically, especially in the south. Still, private capital dominated the construction of the best—and most viciously fought-over—roads. Cornelius Vanderbilt’s New York and Harlem Railroad, then later the Erie, attracted the attention of journalists and the general public, because of the titanic struggles between Vanderbilt and a bevy of opponents, including Jim Fisk, Jay Gould, and Daniel Drew.

Until that point, the extent of most governments’ involvement with the railroads took the form of legislators’ and aldermen’s taking bribes in return for granting, or withholding, various rights to cross certain territory. This, in turn, allowed those with substantial railroad stock to manipulate the market in railroad securities. Of course, for every buyer there must be a seller, and to the dismay of Fisk, Gould, and Drew, the Commodore often would not be (pardon the pun) railroaded: quite the contrary, Vanderbilt sent his own agents into the securities market to sell when his opponents tried to drive prices up, or to buy when they tried to drive them down. His massive transactions often disrupted the schemes of stock manipulators, and in the process he taught the silent partners in Albany lessons they never forgot.

By the Panic of 1857, most railroads relied on private investment. The depression of that year put many of them into bankruptcy, however. Ironically, while economists have for years thought that the origins of that panic lay in disruptions of the wheat market or foreign instability, it turns out that the Dred Scott decision—which overthrew the Missouri Compromise and opened up all territories to slavery—so terrified investors that the bonds of east-west roads collapsed. (Significantly, none of the roads running predominantly north and south collapsed, because their future business and traffic would have been relatively unaffected by the decision.)²

What would have become of the rail networks had the Civil War not intervened, of course, is difficult to determine. It is likely that, had slavery been prohibited from the territories per the Missouri Compromise post-1860, a normal construction program by private investors, largely absent state government intrusions, would have occurred. It is worth noting that the single most important business transformation in American history—the rise of the so-called “managerial hierarchies”—had already taken place in the private sector to address the capital needs of the railroads—a full decade before the first government-backed transcontinental railroad was launched.

Move Along, No Consumers Here

For many years, the nation had sought to support construction of a railroad to the Pacific for military reasons—largely to supply the forts on the frontier, but also to ensure quicker and more reliable support to California and Oregon. If there was agreement over the necessity of a transcontinental, there was disagreement over the route: southerners wanted a route running from Nashville or New Orleans, while northerners wanted a Chicago locus. It was Senator Stephen Douglas’s introduction of legislation to build a railroad through Nebraska that had touched off “Bloody Kansas,” and, eventually, the war itself. When the Civil War broke out, the Union government needed California’s gold and silver as well as the endless supply of horses and cattle provided by the frontier west. Supply lines were secured by the army, and Congress, without southern opposition, immediately passed the Pacific Railroad Act of 1862, which became a badly flawed blueprint for most of the transcontinental railroads. Under the Act, the government gave the railroad a substantial land grant (which was within its constitutional authority to do, and fit the Articles of Confederation’s provisions of the Land Ordinance of 1784 that reserved four sections of every township to the federal government).

Having the authority and using it wisely were two different things, however, and the free land proved as much a curse to the railroads as a blessing. But the other part of the Pacific Railroad Act involved a provision to give a subsidy to the construction of railroads in the form of United States bonds that the companies could sell on the market, then apply the proceeds to construction costs.

Under any circumstances, this was bad economics. The structure of the subsidies, though, proved even more short-sighted. For each mile of track constructed, the railroad received $16,000 worth of government bonds, rewarding the railroad for miles of track laid instead of actual services provided.

Despite what appear as lucrative inducements to modern Americans, few investors jumped at the opportunity to invest in a transcontinental railroad. People could do the math, and they concluded that it would be decades before such a project turned a genuine profit. There simply were not enough customers on the Great Plains to support the railroads. Congress thus sweetened the pot, doubling the land grant and allowing the railroads to sell their own bonds in addition to the government securities for construction. To make a long story short, this resulted in the infamous Credit Mobilier scandal.

After the government had sufficiently jump-started the Union Pacific and Central Pacific, another competitor subsidized by government land grants, the Northern Pacific, also entered the building frenzy. Whatever other feelings this must have evoked from Native Americans, the sight of these endless and obviously expensive tracks must have struck them as incredibly silly. The Indians, because they negotiated the Plains regularly, saw that even after the sodbusters arrived there were no people out there to speak of.

One railroad builder did not rely on government land grants or bond subsidies for his transcontinental railroad. James J. Hill, a Canadian who was blind in one eye, had started his own transcontinental by steadily marching across Minnesota. Hill recognized the simple economic fact that the other roads missed—largely because they were on the government dole—that there were no customers for the railroads to serve. To that end, Hill decided to create his own customer base, a strategy that would have remarkable implications for the telecom industry in the 21st century. He enticed future customers—in this case, farmers—to places where his railroad ran by offering them land. In a direct inversion of the practice of the other roads, namely getting land from the government, Hill bought land and gave it away! Hill also experimented with a variety of new wheat strains, cattle breeds, and agricultural advances that would keep his future customers profitable, in the process putting his railroad in the black. Burton Folsom’s The Myth of the Robber Barons has thoroughly dealt with the stark differences between the government-funded transcontinentals and the Great Northern. For our purposes, the key factor is that Hill did not “build ahead of demand,” but rather ensured through his own efforts that the demand would be there when he needed it. It was the ultimate essence of Say’s Law.

Back to the Future

Jump ahead now more than a century to the late 1990s and the exploding telecom, wireless, fiber-optic, and high-tech boom. Once again, there are concerns that businesses are building ahead of demand. But the comparison to railroads doesn’t hold water. The railroads—at least, all but the Great Northern—were subsidized by the government and had no incentive to develop a customer base.

Indeed, the government was the customer until the legislators finally took away the golden goose. By the 1880s enough people had moved into the Great Plains and onto the frontier to obscure what had happened: the government had constructed several roads that would not have been profitable if left to their own resources, or at least not using the strategies that operators employed with Uncle Sam.

Economists have beaten the railroad data to death, and while there is near unanimity on the fact that the railroads provided “social savings” in the neighborhood of 5 to 15 percent of GNP by 1890, these conclusions universally ignore the dynamics of a free market. “Social savings” is a term that postulates general benefits to everyone (lower travel costs and shipping prices) that might not have existed in the absence of the railroads. The best that economists have come up with to actually test these theories is an imaginary—but potentially real—system of interstate canals that could have been constructed in place of the railroads. Again, however, proving that no private investors would have built the railroads in the absence of subsidies is impossible. Moreover, it is unlikely none would have done so, given the history of not only Hill and Vanderbilt, but also of the intrastate railroad construction prior to 1860. In other words, absent the government, the railroad entrepreneurs in the 1800s knew their market and had a good grip on the size of the customer base.

For the telecom industry in the modern period, the pundits are solemnly nodding their heads in unison that the “fiber barons” do not know their industry or their customer base—that they “built ahead of demand.” But is that the case? The Wall Street Journal has even argued that, to paraphrase Senator Fritz Hollings, “There’s too much competin’ goin’ on out there.” Further, competitors came in, the Journal implied, because of the “easy availability of funding.” Aha! All those stupid capitalists were so anxious to lose their money that they marched into fiberworld like lemmings, dumping millions into dark cable, all because of the “easy availability” of capital.

One must pause, then, to consider the warnings of tech guru and prophet George Gilder, who has for a decade warned that the high-tech industry (and bandwidth/cable in particular) is underfunded! The key to Internet growth has been the venture capital firms, the top 20 of which, from 1974 to 1995, beat even Warren Buffett’s well-known Berkshire Hathaway returns of 32 percent per year. Following four years of George H. W. Bush and two years of Bill Clinton, the investment in technology firms began to wane.

Three things heated up the Internet economy after 1994, however. First, energy prices continued to remain low and as silicon chip companies gobbled up electricity at rapidly accelerating levels, this component of their price fell steadily. Second, Web browsers appeared in 1994, making the Internet genuinely commercial. Third, the GOP Congress lowered capital gains taxes to 20 percent, while the Fed kept the lid on inflation, with prices rising at a tolerable 2 percent in the 1990s. Low interest rates, low energy costs, and low taxes—you can’t beat that combination for economic growth, and the sector that is on the cutting edge will grow the fastest.

Magnify all of this by the “Law of the Telecosm,” which states that the value of a network grows by a square of the processing power of all the terminals attached to it, and “Gilder’s Law,” which postulates that bandwidth grows at least three times as fast as computing power, and the high-tech economy of the 1990s became a skyrocket. The United States rode this skyrocket, claiming some 80 percent of the Web domain names and dominating Internet traffic. At the same time, the cost of manufacturing the “nuts and bolts” of computer—chips—shrank to almost immeasurable proportions, falling at rates of nearly 70 percent a year and forcing the price of a bit down to a millionth of a cent. Although the Journal may question the claim that Internet bandwidth and traffic are doubling every few months, even its own position—that traffic is doubling more like once a year (based on a single AT&T researcher’s paper)—if true, is still an astonishing growth rate. Given this incredible level of expansion, is there anyone out there—aside from the Journal staff—who seriously wants to argue that the availability of venture capital has grown at exponential levels to match the rest of the Internet?

Low interest rates have not sparked a torrent of new venture capital. Nor has anticipation of the desperately needed, but modest, Bush tax cuts. Part of the bottleneck in venture capital has rested in the Byzantine FCC laws governing bandwidth and the monopoly positions of the Bells. Supposedly the 1996 Telecommunications Act required the Bells to unload their networks and free up local areas to competitors, and in return the Bells would receive the authority to re-enter long-distance data transmission. A burst of new “competitive local exchange carriers” (CLECs) suddenly appeared, only to find that the Act did not provide a timetable for or fines for not allowing the competitors into the loops. Then U.S. Representatives Billy Tauzin and John Dingell introduced legislation to allow the Bells into long-distance data transmission regardless.

Complaining that the “companies focused on the easy part of building a network [while] too little money went into [getting] into homes and offices,” or a phenomenon called the “last mile” connections, the WSJ nevertheless admitted that the culprit might be the Baby Bells, which owned most of the “last mile” connections, not venture capital. Where the WSJ sees plummeting prices for dark fiber and the tech stock leaders, however, analysts such as Gilder see nothing but opportunities and market-driven growth. Falling prices are to be expected and celebrated, Gilder would argue.

Internecine Debate

The proper course of action on the Baby Bells, for the time being, is the fulcrum of analysis, pitting free marketeers with different solutions and approaches to de-monopolizing against each other. On the one hand, the “pure” marketeers such as Gilder brushed aside the impact of anti-Bell legislation, arguing that it was irrelevant in the long run what the Bells did. The key, he maintained, was fiber, which “trumps both copper and the airwaves,”³ and cable companies, not the Bells, command the fiber. And since the important regulations were those governing cable, the Bell monopoly-related legislation was a sideshow: the real action was under the ground.

Other bona fide free marketeers saw the Tauzin/Dingell legislation as a crippling blow to the telecoms. William Lehr, an MIT economist, and James Glassman of the American Enterprise Institute constructed a stock index of the CLECs and found that their market capitalization plunged in direct proportion to the Tauzin/Dingell legislation’s progress.⁴ However, Gilder responded in an “open letter” to the new FCC chairman that these CLECs were merely “litigation shops” intent on forcing the Bells to share their copper.⁵ They were not, he maintained, interested in dynamic change.

Gilder’s solution is perhaps politically unfeasible, but eminently sensible: let the cable companies make hay out of their temporary monopoly status. Forget the Bells, and give them the profits from copper. As he correctly notes, no Internet advantage will last more than a fleeting moment. Quit trying to level the playing field. The market is the ultimate groundskeeper. Competition from broadband, DSL, and other technologies will quickly eliminate any advantages the Bells ever held.

One thing is certain. The Internet, and the glass fibers on which it should travel, has little in common with the transcontinental railroads. One was built by entrepreneurs, one by the government. One caused prices to plummet and services to spread; the other allowed companies to pool and price fix with Washington’s blessing. One still suffers from not enough venture capital, while the other nearly collapsed because of too much free money from the taxpayers. The most interesting result of the comparison of wires and rails is that to succeed, one must waste its resource, bandwidth, because bandwidth is potentially the cheapest commodity in the world, driving costs down. The other wasted material resources, because it was subsidized by the government, driving costs up. James J. Hill would have appreciated the differences.

Notes

1. Rebecca Blumenstein, “Web Overbuilt: How the Fiber Barons Plunged the U.S. Into a Telecom Glut,” Wall Street Journal, June 18, 2001.
2. Charles Calomiris and Larry Schweikart, “The Panic of 1857: Causes, Transmission, and Containment,” Journal of Economic History, December 1990, pp. 807–34.
3. George Gilder, Telecosm: How Infinite Bandwidth Will Revolutionize Our World (New York: Free Press, 2000), p. 266.
4. See James K. Glassman, “Look to Politics to Find Broadband’s Market Cap Shortfall,” www.techcentralstation.com, June 22, 2001.
5. George Gilder and Brett Swanson, “The Broadband Economy Needs a Hero,” Wall Street Journal, February 23, 2001.