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Oligopoly Agreement and the Timing of American Railroad Construction

Published online by Cambridge University Press:  03 March 2009

C. Knick Harley
C. Knick Harley
Affiliation:
Department of Economics, University of Western Ontario, London, Canada.
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Abstract

The railroads in the American West were constructed in a few concentrated building booms. This timing of construction resulted from the alternate creation and collapse of imperfect property rights to rights of way in partially settled areas. These “property rights” arose from strategic behavior within the railroad oligopoly. When enforcement costs of cooperative action were low, the railroads were able to create rents by avoiding construction ahead of demand. When enforcement became difficult, however, construction was the only way to capture rents on unbuilt lines so a construction boom ensued.

Type
Articles
Information
The Journal of Economic History , Volume 42 , Issue 4 , December 1982 , pp. 797 - 823
Copyright
Copyright © The Economic History Association 1982

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References

1 See Harley, C. Knick, “Transportation, the World Wheat Trade, and the Kuznets Cycle, 1850–1913,” Explorations in Economic History, 17 (07 1980), 218–50.CrossRefGoogle Scholar

2 Fishlow, Albert, American Railroads and the Transformation of the AnteBellum Economy (Cambridge, Massachusetts, 1965), Chap. 4.Google Scholar

3 The data from the Kansas Board of Agriculture are available in machine-readable form made available by the Inter-University Consortium for Political and Social Research. The data for “Adjustments to Resource Depletion—The Case of American Agriculture—Kansas 1874—1936” were originally collected by William N. Parker. Stephen J. De Canio, and Joseph Trojanowski. Neither the original collectors of the data nor the Consortium bears any responsibility for the analysis of interpretations presented here.

For a candid assessment of the quality of these statistics see Malm, James C., Winter Wheat in the Golden Belt of Kansas (Lawrence, Kansas, 1944).Google Scholar

4 These figures are illustrative, but fit the Kansas data fairly well. They are used for illustrative purposes throughout the paper. Fortunately the qualitative conclusions are not enormously sensitive to this exact specification of interest rates, final earnings, and growth rates within a relevant range of values. Obviously more complex examples could be constructed but it seems unlikely they would significantly alter the results.Google Scholar

5 These net earnings will, of course, be just paying the rate of interest (6%) on the total capital invested. This total capital is the sum of the initial investments and the foregone compounded interest on this capital.Google Scholar

6 Marglin, Stephen, Approaches to Dynamic Investment Planning (Amsterdam, 1963).Google Scholar

7 Seventeen rather than the 12 years of building “ahead of demand” mentioned above because settlement would grow more slowly in the absence of the railroad.Google Scholar

8 This proposition is a very simple extension of the classical Austrian Capital Theory problem of the optimal date to cut a tree. If the value of the timber increases as the tree grows but at a decreasing rate then the optimal time to harvest is when the rate of increase in value equals the rate of interest. The present value of the timber at time zero, given optimal harvest may be illustrated diagrammatically, by extending a line of slope (l–r) from a tangency to the growth curve to the yaxis. This is a rental value of the timber land. The present value of the growing timber becomes zero when a line with slope (l–r) passing through the origin intersects the growth curveGoogle Scholar.

Although this proposition is generally known it is often not fully appreciated. See in particular Fogel, Robert, “Railroads as an Analogy to the Space Effort: Some Economic Aspects,” Economic Journal, 76 (03 1966),CrossRefGoogle Scholar where he accepts the zero net present value criterion. This was brought to my attention by Barzel, Yoram, “Investment, Scale and Growth,” Journal of Political Economy, 79 (03/04 1971), 216, n. 2.CrossRefGoogle Scholar

9 The efficiency, from a social point of view, of delay depends on an implicit assertion that railroad freight charges equalled long-run marginal cost. If monopoly pricing of rail services existed profit maximizing and efficient timing would, of course, diverge.Google Scholar

10 See Harley, C. Knick, “Western Settlement and the Price of Wheat, 1872–1913,” this JOURNAL, 38 (12 1978) and Harley, “Transportation.”Google Scholar

11 These data are from: Chicago price: Harley, “Transportation,” pp. 246–47;Google Scholar Kansas prices:Parker et al. (see footnote 3 above); Railroad rates: Hyde, John and Newcomb, H. T., “Changes in the Rates of Charge for Railway and Other Transportation Services,” United States Department of Agriculture Statistical Bureau, Bulletin, 15 (1898), pp. 20–28 and 48.Google Scholar

12 A Chicago price of 97¢ implies a local price of about 67¢ a bushel or a bit less at the 99th meridian. The United States Department of Agnculture Yearbook 1893, pp. 515 and 517, estimate the cost of production of wheat, except rent, at between $7.00 and $7.50 per acre. Yield per acre in average years was between 13 and 17 bushels per acre in the mid-1880s and the general price level was some 20% higher than in 1893. These imply costs, excluding rent, of between 50¢ and 70¢ per bushel. Local price would be below 70¢ at the 99th meridian and around 50¢ at the west end of the state.Google Scholar

13 Grodinsky, Julius, The Iowa Pool: A Study in Railroad Competition, 1870–84 (Chicago, 1950);Google ScholarGrodinsky, , Jay Gould: His Business Career, 1867–1892 (Philadelphia, 1957);Google Scholar and Grodinsky, , Transcontinental Railway Strategy, 1869–1893 (Philadelphia, 1962).CrossRefGoogle Scholar

14 Transcontinental Railway Strategy, p. 105.Google Scholar

15 Ibid., p. 114.

16 Iowa Pool, p. 92.Google Scholar

17 Ibid., pp. 97–100.

18 Transcontinential Railway Strategy, Chap. 8.Google Scholar

19 Gould, Jay, pp. 240–44 and Transcontinental Railway Strategy, Chap. 9.Google Scholar

20 Transcontinental Railway Strategy, pp. 96–100; 162–78.Google Scholar

21 For a discussion of the details of this collapse see Grodinsky, Transcontinental Railway Strategy, Chaps. 15 and 16.Google Scholar

22 North, Douglass C., “International Capital Flows and the Development of the American West,” this JOURNAL, 16 (12 1956), 493–505Google Scholar and The Economic Growth of the United States, 1790–1860 (New York, 1961), pp. 66–74.Google Scholar

23 The data used in the regression are described in Harley, “Transportation.” The Kuznets deflator has been extended to the pre-Civil War period on the basis of Gallman's implicit deflator and the Warren and Pearson index. The regressions were also run using a real interest variable which was constructed by subtracting the average price change in the five previous years from the nominal rate. The interest variable remained insignificant. Inclusion of the price of rails yielded a positive regression coefficient.Google Scholar

24 This is the same data set used in Harley, “Western Settlement.”Google Scholar

25 See, for example, Fishlow's, Albert discussion in Davis, Lance E., Easterlin, Richard A. and Parker, William N., et al. , American Economic Growth: An Economist's History of the United States (New York, 1972), pp. 500–05.Google Scholar

26 The same conclusion holds if a “real” interest rate is used.Google Scholar

27 This conclusion is even stronger when allowance is made for expectations of price declines. Prices declined very rapidly shortly after the Civil War but rather more slowly by the mid-1870s.Google Scholar

28 Thus the New York Times (03 16, 1876) stated: “The fact that the money markets of Europe are now closed against new railroad enterprises emanating from this country is too palpable to be denied. The growing disposition to invest in our railroad securitites, which has for some months been one of the characteristics of the London market, manifests itself only within very narrow limits. Investors confine themselves to well known and prosperous companies, whose capital affords ample security for money borrowed and the soundness of whose management has been attested by the uninterrupted payment of dividends during the hardest of hard times.”Google Scholar

The Burlington and the Rock Island were two such “well known and prosperous companies.”