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Entrepreneurs and the State

Burton W. Folsom

Burton Folsom is Associate Professor of History at Murray State University in Kentucky. This article is adapted from his recent book, Entrepreneurs rs. the State (available from FEE @ $14.00 postpaid).

The big story in the U.S. auto industry during 1987 was the sharp growth (+ 35%) in sales for Honda and the decline (- 23%) for Chrysler. While Honda sold cars as fast as it could make them, Chrysler straggled 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 received 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 industries 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-Atlantic voyage by steam in the 1830s, the governments of England and the United States subsidized steamship travel. Samuel Cunard, a political 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 passenger and 24 cents a letter, but still said that he needed the annual aid to cover his losses. He contended that subsidized steamships gave England an advantage in world trade and were a readily available merchant marine in case of war. Parliament accepted this argument and increased government aid to the Cunard Line throughout the 1840s.

Soon, Edward Collins, a political entrepreneur 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 military 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 Canard 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 business against price-cutting rivals. In 1852 he went to Washington and lavishly entertained President Fillmore, his cabinet, and influential Congressmen. Collins artfully lobbied Congress 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. Congress 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 unrestrained 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 uncomfortable—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 passengers 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 passengers. In desperation he spent one million dollars of government money building a gigantic 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 concurred: “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 operator.

And there was yet another twist. When Vanderbilt 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 innovation and delay technological changes in steamship construction.

Unfortunately, this cycle of government subsidy, 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 together. Political entrepreneurs of the day convinced Congress that without Federal aid the nation could not be linked by rail. Most historians 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 unprecendented corruption. The Union Pacific and Central Pacific built shoddy lines very quickly just to capture the Federal subsidies. Also, the Credit Mobilier scandal, in which Union Pacific officials bribed Congressmen with cheap stock in return for favorable votes, rocked the Grant administration and branded the whole railroad industry as corrupt. Eventually, negative public reaction helped lead to the establishment 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 entrepreneur, 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 technology of his day he built a model line—relatively straight, on an even grade, and with high quality steel. He made each piece pay for itself before he moved further west. During the depression of the 1890s, when the subsidized Union Pacific, Northern Pacific, and Santa Fe Railroads went bankrupt, Hill ran his line profitably 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 interest at heart: they are protecting jobs, helping local industries compete, and preserving the industrial 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.

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