The Myth of the Robber Barons

by Burt Folsom

  Here is a key point: the gain in social return was only temporary, but the loss of shipping with an inefficient railroad was permanent. The UP and NP were, as we have seen, inefficient in gradients, curvature, length, quality of construction, repair costs, and use of fuel. This meant permanently high fixed costs for all passengers and freight using the subsidized transcontinentals.

  The subsidizing of railroads cost the nation in other ways, too. First, the land that was given to the railroads could not be sold for revenue. Second, the giving of subsidies to one established a precedent and resulted in the giving of subsidies to many. When the government gave twenty million acres to the UP, the NP and others clamored for aid; the result was the giving of 131 million acres of land to various railroads. Third, the granting of all this land, and money too, made for shady business ethics and political corruption. The Credit Mobilier is an example of poor business ethics, and the CP's tight control over California politics is a sample of political corruption. Part of this corruption is reflected in the automatic monopolies that subsidized transcontinentals had. When Jay Gould doubled rates along parts of the UP, not much could be done. It took time to build privately financed lines; and, when they were done, they had to compete with a railroad that had, thanks to the government, millions of acres of free land and large cash reserves.

  A final hidden cost of subsidizing railroads is seen in the mass of lawmaking, much of it harmful, all of it time-consuming, that state legislatures, Congress, and the Supreme Court did after watching the UP, CP, and NP in action. The publicizing of shoddy construction, the Credit Mobilier scandal, rate manipulating, and bankrupt health spas angered consumers; and angry consumers pestered their Congressmen to regulate the railroads. Much of the regulating, however, had unintended consequences and made the situation worse. For example, when the corruption in the building of the UP became known, there was public outrage followed by a congressional investigation. In the investigating, many were irritated that the UP had made no payment on its government loans. Congress, as we have seen, passed the Thurman Law, which forced the UP to pay 25 percent of its annual earnings toward retiring its $28 million debt to the government. The problem here is that the shoddy construction of the UP made for high fixed costs, and the lack of spur lines limited its chances for profits. This meant that the UP had to raise rates for passengers and freight to pay back its loans. The rate hikes, though, caused even more public outcry: many noticed, for example, that the UP and NP were charging more than the GN did; and this helped lead to demands for rate regulation. Congress obliged and, in 1887, created the Interstate Commerce Commission to investigate and abolish rate discrimination. This created two new problems: first, it was now illegal to give discounts. Hill argued that rate cutting had led to lower rates over the years and that this allowed the United States to capture a larger share of overseas trade. Hill insisted that the ICC law, if enforced (which it eventually was), would hurt railroads in domestic and overseas trade. Second, the ICC law eventually cost the taxpayers millions of dollars every year; it created a need for thousands of federally funded bureaucrats to listen to shippers all over the nation and to snoop into the detailed records of almost every railroad in the country.29

  The issue of foreign trade is important and was hotly disputed during Congress' debates on the transcontinentals. Advocates of federal aid strongly argued that subsidized railroads would capture foreign trade and increase national wealth. "Commerce is power and empire," said Senator William M. Gwin of California. "Give us, as this [Union Pacific] Railroad would, the permanent control of the commerce and exchanges of the world, and in the progress of time and the advance of civilization, we would command the institutions of the world." Yet the UP and NP were so inefficient, they couldn't even capture or develop the trade of their own regions, least of all the world. If Hill hadn't come along and built the privately financed Great Northern, the United States might have forever lost opportunities to capture Oriental markets.30

  Once he completed the GN, he studied the opportunities for trade in the Orient and marveled at its potential. "If the people of a single province of China should consume [instead of rice] an ounce a day of our flour," Hill wistfully said, "they would need 50,000,000 bushels of wheat per annum, or twice the Western surplus." The key, Hill believed, was "low freight rates"; and these he intended to supply. In 1900, he plowed six million dollars into his Great Northern Steamship Company and shuttled two steamships back and forth from Seattle to Yokohama and Hong Kong. Selling wheat was only one of Hill's ideas. He tried cotton, too. Ever the pump-primer, Hill told a group of Japanese industrialists he would send them cheap Southern cotton, and deliver it free, if they would use it along with the short-staple variety they got from India. If they didn't like it, they could have a refund and keep the cotton. This technique worked, and Hill filled many boxcars and steamships with Southern cotton destined for Japan. Hill's railroads and steamships also carried New England textiles to China. In 1896, American exports to Japan were only $7.7 million; but nine years later, with Hill in command, this figure jumped to $51.7 million.31

  An even greater coup may have been Hill's capturing of the Japanese rail market. Around 1900, Japan began a railroad boom and England and Belgium made bids to supply the rails, hi this case, the Japanese may have underestimated Hill: it didn't seem likely that he could be competitive if he had to buy rails in Pittsburgh, ship them to the Great Northern, carry them by rail to Seattle, then by steamship to Yokohama. Hill was so efficient, though, and so eager for trade in Asia, that he underbid the English and the Belgians by $1.50 per ton and captured the order for 15,000 tons of rails. Hill was spearheading American dominance in the Orient.32

  Hill worked diligently to market the exports of the Northwest. Wheat from the plains, copper from Montana, and apples from Washington all got Hill's special attention. Without Hill's low freight rates and aggressive marketing, some of these Northwest products might never have been competitive to export. Washington and Oregon, for example, were covered with Western pine and Douglas fir trees. But it was Southern pine that had dominated much of the American lumber market. Hill could provide the lowest freight rates, but he needed someone to risk harvesting the Western lumber. He found Frederick Weyerhauser, his next-door neighbor, and sold him 900,000 acres of Western timberland at $6.00 an acre. Then Hill cut freight costs from ninety to forty cents per hundred pounds, and the two of them captured some of the Midwestern lumber market and prospered together.33

  Hill became America's greatest railroad builder, he believed, because he followed a consistent philosophy of business. First, build the most efficient line possible. Second, use this efficient line to promote the exports in your section—in other words you must help others before you can be helped. Third, do not overextend; expand only as profits allow. Hill would probably have agreed with Thomas Edison that genius is one percent inspiration and 99 percent perspiration. Few people were willing to exert the perspiration necessary to learn the railroad business and apply these principles. Many, like Villard, Gould, and Stanford, took the easy route and chased subsidies, hiked rates, and manipulated stock; but this approach never built a winning railroad. "If the Northern Pacific could be handled as we handle our property," Hill said, "it could be made [a] great property ... but it has not been run as a railway for years, but as a device for creating bonds to be sold." Hill understood markets, prices, and human nature; when he saw what his rivals were doing, he ceased to fear them.

  The only thing that Hill did seem to fear was the potential for damage when the federal government stepped in to direct the economy. He understood why this happened—why people pressured Congress to involve itself in economic matters. California, isolated on the Pacific coast, wanted the cheap goods that a railroad would bring. So Senator Gwin lobbied in Congress for the UP. American steel producers wanted to sell more steel, so they pushed Congress to put a tariff on imported steel. Hill's problem was that, when his rivals were subsidized and when tariffs forced
him to pay 50 percent more for English steel, he had to be twice as good to survive. One way out, which Hill took, was to support those politicians in the Northwest who would fight subsidies and high tariffs, and who would urge Congress to give him the right-of-way through Indian land.34

  What Hill ultimately deplored more than tariffs and subsidies were the ICC and the Sherman Anti-trust Act. Congress passed these vague laws to protest rate hikes and monopolies. They were passed to satisfy public clamor (which was often directed at wrong-doing committed by Hill's subsidized rivals). Because they were vaguely written, they were harmless until Congress and the Supreme Court began to give them specific meaning. And here came the irony: laws that were passed to thwart monopolists, were applied to, thwart Hill.

  The ICC, for example, was created in 1887 to ban rate discrimination. The Hepburn Act, passed in 1906, made it illegal for railroads to charge different rates to different customers. This law was partly aimed at rate manipulators like Jay Gould. But it ended up striking Hill, who now could not offer rate discounts on exports traveling on the Great Northern en route to the Orient. Hill had given the Japanese and Chinese special rates on American cotton, wheat, and rails to wean them to American exports. But the Hepburn Act, according to Hill, immediately cut in half American trade to these countries. Hill testified vigorously during the Senate hearings that preceded the Hepburn Act, but was ignored. He was furious that he now had to publish his rates and give all shippers anywhere the special discount he was giving the Asians to capture their business. Since he couldn't do this and survive, he eventually sold his ships and almost completely abandoned the Asian trade.35

  "Rates vary with conditions," Hill said.

  They vary from day to day, almost. I was much struck by some of the questions [addressed to the previous witness during the Hepburn Act hearings] as the difficulty in fixing what is a reasonable rate by law. You are dealing with the questions that exist today. Can you apply the conditions that exist today to tomorrow or next week or next month? It is absolutely impossible. ...

  The Hepburn Act, though, said rates had to be made public, applied equally to all shippers, and could not be changed without thirty days notice. American exports to Japan and China dropped 40 percent ($41 million) between 1905 and 1907, and we will never know how much trade, domestic and foreign, was lost elsewhere.36

  Another federal law that was aimed at others, but which struck Hill instead, was the Sherman Anti-trust Act. As written, the Sherman Act banned "every combination. . .in restraint of trade." This vaguely written law was an immediate problem because every act of trade potentially restrains other trade. This meant that the courts would have to decide what the law meant. The first test of the Sherman Act, the E. C. Knight case (1895), liberated entrepreneurs to freely buy and sell. The American Sugar Refining Company had bought the E. C. Knight company and thereby held 98 percent of the American sugar market. The Supreme Court upheld this acquisition because no one had tried to "put a restraint upon trade or commerce." No one stopped anyone else from producing sugar and competing with American Sugar Refining. Therefore, the trade was legal even though "the result of the transaction. . .was creation of a monopoly in the manufacture of a necessary of life. . . ." In fact, other sugar producers did enter the market and steadily whittled the market share of American Sugar Refining from 98 to 25 percent by 1927.37 With the E. C. Knight case the law of the land, Hill saw no problem when he created the Northern Securities Company in 1901. After the Panic of 1893, Hill bought a controlling interest in the bankrupt NP and sometimes used it to ship his own freight. In 1901, Hill added the Chicago, Burlington, and Quincy to his holdings; this allowed him to tap markets to the south in lumber, meat-packing, and cotton. That same year he placed his stock in the GN, NP, and CB&Q in a holding company called the Northern Securities Company. Hill pointed out that in doing this he was not restraining trade; he was combining three smaller companies he already controlled into one larger company. Actually, competition among the transconti-nentals was keener than ever. Edward H. Harriman had taken over the bankrupt UP after the Panic of 1893 and, free of governmental restrictions, had plowed $25 million into new track, new routes, new equipment, and spur lines. He adopted Hill's philosophy of building an efficient railroad and promoting the exports of the region. Harriman even bought steamships and prepared to challenge Hill in the Orient. When Harriman tried to buy into the NP, a stock fight resulted, and financierj. P. Morgan suggested the creating of a holding company, the Northern Securities, to prevent stock manipulation on Wall Street. Hill would be president of the Northern Securities and therefore keep control of his three railroads; Harriman would serve on the board of directors. Competition was not stifled; in fact, rates fell on both the GN and the UP in the two years after the Northern Securities was created.38

  Hill was therefore disappointed when President Theodore Roosevelt urged the Supreme Court to strike down the Northern Securities under the Sherman Act. He called the Northern Securities a "very arrogant corporation" and Hill a "trust magnate, who attempts to do what the law forbids." But, of course, no one knew what the Sherman Act did or did not forbid. To lead his defense, Hill hired John G. Johnson, who was the "successful warrior" in the E. C. Knight case. Johnson defended the Northern Securities in much the same way he had defended the E. C. Knight Company. He argued that the Northern Securities did not restrain trade or bar other railroads from entering the Northwest; he then attacked the Sherman Act for being "so obscurely written that one cannot tell when he is violating [it]. . . ." With the E. C. Knight case as a precedent, with rates falling on Hill's railroads, and with competition stiff between the GN and the UP, Johnson argued his case with confidence.39

  In 1904, however, in a landmark case, the Supreme Court decided five to four against the Northern Securities. It had to be dissolved. Hill was especially irritated at Justice John M. Harlan, who wrote the majority opinion. The Northern Securities was, according to Harlan, "within the meaning of the [Sherman] Act, a 'trust'; but if it is not it is a combination in restraint of interstate and international commerce; and that is enough to bring it under the condemnation of the act." Harlan continued with a devastating statement: "The mere existence of such a combination...constitute^] a menace to, and a restraint upon, that freedom of commerce which Congress intended to recognize and protect, and which the public is entitled to have protected."40

  The Northern Securities decision, then, overturned the E. C. Knight case. Now "the mere existence" of a large corporation was seen as a threat to trade and therefore unlawful. Justice Oliver Wendell Holmes wrote a dissent which credited this astonishing verdict to an unsophisticated, but widespread belief among the public, in Congress, and in the courts that big corporations must necessarily be bad ones. "Great cases," Holmes concluded, "make bad law." Meanwhile Hill had to abolish the Northern Securities, as well as his trade with the Orient.41

  A look at the story of Hill and the railroads shows again the harmful, but unintended consequences that followed federal tinkering with the economy. The goals for federal intervention sounded so noble: subsidize a railroad to conquer the West and then the world; strike down those corporations that "restrain trade." Yet these noble goals were soon lost in an eddy of tragic consequences. In the case of the Sherman Act, Harlan's interpretation was applied again and again. Since "the mere existence of such a combination" as the Northern Securities was bad, all large corporations now had to fear prosecution. Just how much this hurt American trade, at home and abroad will never be known. Robert Sobel and other business historians have argued that this fear of being too big made some corporations stifle innovation and reduce their dominance in their industries in order to protect inefficient competitors. General Motors and IBM are frequently cited as examples of companies that dulled their competitive edge to help their rivals survive.42

  Hill was sad and predicted that the ICC and the Sherman Act would ruin American railroads and threaten cheap trade throughout the nation. A 72-year-old Hill would e
ven write a book, Highways of Progress, to argue this point. But his last days seem to have been happy. He had built the best railroad in America and had used it to beat subsidized rivals time and again. He helped open the Northwest to settlement and the Orient to American trade. He had made a difference in the way the world worked. To some viewers, he was the real hero in the drama of the American transcontinental railroads.

  CHAPTER THREE

  The Scrantons and America's First Iron Rails

  Steamships and transcontinental railroads were obviously important to America's industrial revolution. Even more critical, however, was the iron and steel industry itself. A successful iron industry could be the means of manufacturing a variety of cheap products to sell at home and abroad. With iron, for example, Americans could mass-produce rails and use them to cut transportation costs, open markets out west, and speed new products to cities throughout the nation. In the world of the 1800s, if a nation could produce cheap iron and steel, it could shape its own destiny.

  The problem for America was that Englishmen controlled the world's iron markets. They had developed the first blast furnaces, and they had also invented the puddling techniques needed to purify molten iron. They likewise had a generation of skilled iron-makers eager to compete on a world market. In short, they had a large head start and, during the 1830s, used it to build all of America's iron rails. They also sent America iron-tipped plows, locks, nails, and all of the cast-iron pipes used for the nation's water system. By 1840, dozens of Americans were frantically tinkering with different types of fuels, ores, and blast furnaces, trying to produce American-made iron.1