Crisis and Liberty: Lecture 3

0:00Before I start, I want to call your attention to something that has just gone online. It's a website called OnPower.org. This is one of the projects of the Independent Institute, which I work with. It started out a year ago or more to be a website connected with my book, Crisis in Leviathan, and other things that I've written on related themes and topics, but it grew and turned out to be about a hundred times bigger than we had in mind to begin with.

0:47and it doesn't just deal with my work, although much of my work that relates to the growth of government and related topics is there and a great deal of it is available in hyperlinks so that you can get access to the text online. but a tremendous amount of other material is also listed there and organized in subject areas, things having to do with the various aspects of government policy making or action according to different historical periods and according to different parts of the world.

1:32So it's really quite a comprehensive resource for people interested in tracking down material. The reading lists, which is in a sense what this site contains, are really marvelous. I look at it sometimes and I think, I only wish I'd read more than a small fraction of of all this material myself and I have that same sinking feeling I had when Murray Rothbard wrote that letter years ago. There's a lot to learn and I'm not very far along, but this is a wonderful resource in this area. I'd say it's different in flavor from anything This is something I know about. It's quite similar, however, to the flavor of suggested readings you get from mises.org and has a great deal of overlap, indeed, with many of the authors you find there.

2:38But I recommend this to you. Have a look at it. See what you can do with it. I think you may find it very useful. And especially if you ever should find yourself in that curious position of wanting to track down something I've written, if it's about the growth of government or a related topic, born policy critiques, or anything along those lines, you're likely to find the text online at onpower.org, so I commend that to you. This morning I want to talk about the 19th century and the growth of government during that time. Yesterday I put a graph up showing the growth of federal spending from, I think, the very beginning, from 1790 or so all the way up to recent years.

3:36and one of the striking aspects of that chart is that except for the Civil War, federal spending in the 19th century is always very, very low, runs two or three percent a year at most and jumps up during the Civil War but then it comes back down. and so it looks as if government didn't amount to much by that measure. What I want to do today is to look also at state and local levels of government because they were actually much more important in many ways so far as intervening in economic life was concerned in the 19th century and also to talk about some of the ways in which the Federal Government did play an important role but a role that doesn't show up in that graph because it doesn't get reflected in the amount of money the Federal Government was spending.

4:53So, that's the topic today and then I'll begin later on this morning to discuss some of the ways in which structural changes in the late 19th century with the development of the national market and so-called big business began to change the regulatory landscape and to create some curious The curiosities, so to speak, in federalism. There was a sense in which I think federalism contained the seeds of its own destruction under the conditions that prevailed then and later.

5:38And it's an idea that I haven't seen discussed a great deal, but I think has some importance. We have some data here which are the product of some very extensive research undertaken by Dick Silla and John Wallace. John was a Ph.D. student of mine from the University of Washington years ago. and John Legler and these guys have been digging up information for many years. It's very hard to find state and local budget data in the 19th century, particularly in the early 19th century, just literally finding it. Where is it? Are any records remaining?

6:37And then when you find it, making some sense of it and trying to organize it in a way that It can be made comparable to other information. Federalism was not a system made with historian's ease in mind. So there's a lot of different jurisdictions to examine. But out of all of this work, John Wallace compiled these data. They're published a few years ago in a very nice survey article in the Journal of Economic Perspectives. And the national data are fairly familiar because they're easy to get and they've been available for a long time.

7:29But the state and local data are basically information that was available only in rough guesses before. Now obviously these data are subject to some errors as well, so I don't want to pretend that they're very, very precise, Nor would Silla, Wallace and Legler pretend that. They're still working on this project. But I think they're the right orders of magnitude and they show us the correct trends. And they're quite revealing. You'll notice for example that when we are first able to look at all three levels of government here in 1840, We find that the revenues of the national government at that time are a little greater than those of local governments, but not much, and less than twice as much as the states are getting in revenues.

8:40And interestingly, as time goes by, the movement is in the direction of relatively more growth at the state and local level rather than the national level. By the time we get to the end of the 19th century, the local governments alone, The cities and the counties are getting more revenue substantially than the national government. The states haven't grown at nearly such a high rate, but they're not inconsequential either. Now to get some idea, these numbers are expressed in current dollars per capita, and of course We look at this and we think, what a heaven, even if money had 20 times the purchasing power that it has now, which is probably in the right neighborhood, still these seem like negligible levels of taxation by modern standards, so it's almost enough to make us believe there was laissez-faire after all.

9:53But when you look at the far right-hand column and you see these revenues as a percent of GNP, yes, again, they're small compared to modern levels. The government's now getting more than 30% of GDP in revenues at all levels, and that's a lot more than 7.2%. But 7.2% is not nothing. Governments were out there, they were doing things in the 19th century, they weren't just sitting on their hands reading books on anarchism. So this is kind of an overview of where things stood at the various levels of government in the 19th century.

10:48Now again, as I said, in the beginning of the 19th century, the national government wasn't even trying to do very much, especially after Jefferson became president. The excise taxes that the federal government had tried to collect in the 1790s were almost all abandoned during Jefferson's administration. There was an excise on salt at the federal level that remained in effect, but otherwise there weren't any until the second war with England, and then they were only put back in place for a few years to get some revenues to help pay for the war. So, the national government got its revenues predominantly, that is to say about 80% or more, from tariffs and almost all the balance came from sales of land in the public domain.

11:51So, I mean, it's almost as if that wasn't even a tax, at least you got some land in exchange for your money. So the national government didn't have much penetration in a way that modern tax systems have. In the 20th century, tax authorities decided that you wanted to use the tax system not just to get revenues so that government could make purchases. You wanted to use it to affect behavior. You wanted to use it to penalize or refrain from penalizing different kinds of business and different kinds of even personal action so that nowadays, for example, anti-smoking crusaders are gung-ho to place extraordinary taxes on cigarettes.

12:43All of us here understand what a counterproductive notion that is because in fact when you put a high tax on cigarettes as say New York City has recently, cigarettes get cheaper because it stimulates all the smugglers to bring in cigarettes with no tax at all. and so strange as the idea is nonetheless moralists and do-gooders and crusaders and social engineers and all the rest of the busy bodies the world is plagued with discovered the tax system in the 20th century and so they want to continually monkey with it so that they can make people do what they want them to do and they don't seem to ever learn their lesson about the difference In the 19th century, taxes were a little more straightforward.

13:43They were pretty much a way government wanted to get revenue, but not entirely. Even there, when the federal government did go back to imposing excises during the war between the states, it put thousands of them on. It put them on everything it could think of where it might be able to collect them. and after the war ended it didn't give up all of them and it's instructive that the ones it kept were the ones on liquor and tobacco because even in 1865 this country had a fair share of busybodies who wanted to dictate how their neighbors lived.

14:30And so, in fact, we've had that federal tax on liquor and tobacco continuously from this war between the states till today at the federal level. But that, again, that was an exception. At the local level, most of the tax revenue came from property taxes on real estate, just as much of it still does. The states laid various kinds of taxes on people but again a relatively small amount of revenue was acquired by the states. They didn't do much in the 19th century. They had a kind of a long list of actions that they undertook but none of them amounted to a very big deal in terms of the The revenue data don't tell us some of the ways in which states became very actively engaged in economic life in the early 19th century.

15:41One of the important avenues for that sort of activism was in banking. You'll recall that the Constitution of the United States forbids states to issue bills of credit, paper money. Prior to the Constitution's ratification, most of the states had been issuing paper money. And indeed, that issuance was a major complaint for most of the founding fathers, Because they viewed that as a way of cheating creditors. And indeed, that's what it was intended to be. The states issued this paper money.

16:26You know, the first thing it did was cheat the people they owed. And then the paper money got out into circulation and was used to repay debts, and of course depreciating all the while, thereby becoming a vehicle for the debtors to cheat the people they owed who had expected to be repaid in many cases, if not all, in hard money. So this became a major issue leading up to the Constitutional Convention and the insertion of that provision against states issuance of bills of credit. Now, as it turned out, the states kind of laughed off this restriction because almost immediately they started getting involved in either establishing banks on their own account, that is, you know, socialist banking is what it was, so the states just set up banking institutions and started accepting deposits and making loans and investments just as a regular private commercial bank does.

17:37So, many of the states went into the banking business. Others, although they didn't or even if they did, in addition to that, they became investors in private banking companies. And, of course, all of these banks then proceeded to create deposits for their lenders, for their borrowers, and to issue paper money. So, if the Constitution said you can't state of Rhode Island, issue paper money, didn't prevent Rhode Island from establishing the Bank of Rhode Island, which issued paper money.

18:25And this kind of activity was rampant in the first half of the 19th century. It began to fade out around the middle of the 19th century, largely because these enterprises tended to go broke. They were, of course, badly managed being public enterprises. and failure was not an uncommon event in the banking industry anyhow, so these were especially likely to fail and many of them did and in some states in the 1840s, new constitutions were written forbidding the states to engage in banking anymore. So that was one of the ways in which the states did play an important role because these banks all acted as a kind of crony capitalism.

19:22Your pals were the ones who got the loans and politics dictated how these institutions operated. There are even matters such as where they put their branches. If they had branches, which county would get a branch of the State Bank of Iowa, for example. I had an interesting article a few years ago in my journal, The Independent Review, on some of the state banks in the Midwestern states that were still operating in the 1860s. Some of them so it took a while for this this sort of thing to be be driven away In addition the states became heavily engaged from oh about the second decade of the 19th century and investing in transportation improvements, especially in canals between about 1815 and 1840 And in the beginning, New York State really showed the way by building the Erie Canal, which linked basically Albany and Buffalo, and by virtue of making that link, it allowed waterborne trade to proceed all the way from the Atlantic Ocean to the Great Lakes

20:57and via the Great Lakes to penetrate far inland, farther indeed than anybody cared to penetrate at that time. So this was really a tremendous boon to the development of that part of New York State. First of all, even before the canal was completed in 1825,

21:23there was a tremendous boom of settlement and Development of Agriculture and Industry in the areas nearby the canal and then the state built feeder lines out from the main stem line and so it did a lot to draw people and industry to that part of the country. Now, the politicians in other states looked up at New York and said, ah, they're getting the jump on us. Just the way your politicians here in Alabama looked around recently, I take it, and said, somebody's getting the jump on us, let's throw some of our money at Hyundai Corporation. I noticed that sign when driving up here on Sunday that Hyundai is building a big plant The other side of Montgomery, I told Elizabeth, pity the poor tax payers of Alabama, Hyundai's not coming here by accident, I guarantee they've been subsidized to do that, and this was a game that states were already playing almost 200 years ago. They've never quit, they've I've never quit because this is a form of corruption that state legislators and governors and their flunkies get away with.

22:51It's based on economic fallacy, but it's a fallacy that the public can easily swallow and continues to swallow, and so it's politically viable and I don't see any end to it. just like this state of the weather you know tornadoes come sometimes Hyundai comes other times and they'll take credit for it when it comes that's the that's the bizarre part well the next thing that happened after the Erie Canal was built was that several other states said well we got to do this too New York is going to suck all the commerce away from us because it was indeed promoting the growth of the Port of New York where a lot of this commerce from the West was brought down the Hudson River to New York and then in some cases exported to Europe or elsewhere. So New York City was flourishing and Philadelphia said we can't have this, we're losing our and our preeminence, not to speak of money, and Baltimore said, we can't have this, and even some vagrant politico down in the swamps of the District of Columbia said, well, we can't have this either, we've got to have a canal too.

24:16And so they began to build canals of their own at public expense, more or less connected to these port cities. And elsewhere in the country, a number of large canal projects were undertaken also by state governments. Even out in the wilds of Ohio and Indiana and Illinois, which was so far away you couldn't see it even with a telescope. People decided they had to build a canal that would basically connect Chicago via the Illinois River and eventually hook into the Mississippi River down in the southern part of the state.

25:03They started digging all these trenches and using taxpayer money to do it. Eventually they completed some of them. As it turned out, none of them had the effect that the Erie Canal had had in New York, perhaps because they were too late. The Erie Canal had already, in a sense, got its foot in the door of connecting the Western economy, the one beyond the Appalachians. You'll recognize this as the Appalachian Range, of course, here. And that was the problem for early Americans, is that they all lived here on the east side of the Appalachians, which Easterners call mountains. I never understood why, being a Westerner, but they were a big barrier in those days.

26:01and once you got through there somehow, you had a means of connecting with a lot of potentially lucrative trade because that interior area was definitely going to be settled. Everybody knew that. It was just a matter of time and where and when the pockets of development would appear. So New Yorkers got up here and you'll recognize these squiggles as the Great Lakes and once you got into there, you could go and then come down rivers or canals that were built in the West and have access to the entire area almost of the old Northwest Territories, which is a huge, fertile, productive, magnificent area just crying out for land speculation.

26:55and that was what Americans did above all else you know you can call Americans a lot of names but basically what we've we've been from the beginning is land speculators and smugglers yeah well some of us didn't have access to water These investments in canals almost all went broke at the end of the 1830s and the beginning of the 1840s. At the time they went broke, many of them were not completed yet, especially those out in the Midwest.

27:41And they ended up saddling taxpayers with a lot of debt obligations, with nothing to show for it. And a lot of citizens became quite angry about that situation. And again, new constitutions were written in a number of states in the 1840s, not only to keep states out of banking enterprises but also to prevent them from investing in canals. So it wasn't that states stopped channeling money into transportation improvements, they didn't. They began instead to channel aid to railroads about the same time, The railroad was first built in 1830 in this country. It really developed quickly in the 1850s and afterward.

28:45Every time a railroad passed through anywhere in this country, the owners would prevail on every county, town and city nearby for some kind of subsidy. and very often they got it. One way they got it was by threat, by threatening to go somewhere else with their railroad line and towns even whole counties recognized if the railroad bypassed them then economic development was going to bypass them too to some extent at least and thus their land values wouldn't go up Remember, that's what we Americans care about, is getting that unearned increment, as it were, in Henry George's terms.

29:42So these companies were continually playing off local governments for subsidies, and they got them in various forms. Sometimes they got cash grants. Sometimes they got guarantees that the state or the city or county would stand good if the railroad company couldn't pay its debts on time. and sometimes they got tax forgiveness and that was pretty common just as I'm sure Hyundai's getting a period of tax forgiveness maybe in perpetuity oh just 25 years okay well it'll polish me off so so you could engineer these boondoggles in various ways, and they tried them all, and that was an important way in which state and local governments got involved in manipulating the course of economic events in the 19th century. Again, a lot of this activity doesn't show up in the budget anywhere. If a county guarantees a million dollars worth of Illinois Central's debt, well, it doesn't show up, Especially if it never has to make good on that promise, but it still has an effect on the allocation of resources.

31:16It determines how much gets used, where, when, and how. So it distorts the market system. And indeed the market system was subject to all kinds of distortions of this sort in the 19th century. Even though, again, it looks like an era of small government, it was an era when graft was quite well known to public officials and citizens, and they engaged in all sorts of corruption. So those are just some of the ways in which states and local governments were bigger than we might think. Now, in the late 19th century, as urbanization began to really pick up, and many large cities developed in this country, at that time, you could no longer just let a city develop willy-nilly, or at least citizens didn't want them to develop that way, with mud for streets, and no sidewalks, and no lighting, and no sewerage, and no water supply, and what have you.

32:29So, as cities developed in the late 19th century, they were called upon. I think there was a legitimate demand by the people who lived there for this kind of infrastructure investment. and they proceeded to undertake it and it was a massive amount of work to build all of these streets and pave them and build sidewalks and put in lighting and particularly in the 1880s and onward, sewerage systems and water supply systems. those are very big projects they took a lot of investment and so when you look here at the local government spending you see it it doesn't look at between 1870 and 80 and 90 as if it's really changed it has because the price level falls quite a bit during that period so in real terms it's going up and then in the 1890s it takes a serious jump because there's even more of that kind of infrastructure investment going on at that time and into the early 20th century.

33:41Those are the days when we began to get drinking water that wouldn't necessarily give you cholera or typhoid because cities began to install water filtration systems and so-called sanitary sewers so that they were properly piped and didn't allow the sewage to get mixed up with the water and the water pipes. We take these things for granted now, but I can easily recommend places to you where you don't take them for granted, and you miss them actually when you're in a place where you can't drink the water and you don't have a proper sewer system.

34:27This was a big deal for local governments, especially for city governments. Big cities did the whole range of this kind of infrastructure investment. A lot of smaller towns didn't do it for a long time until well into the 20th century. Okay, well, let us return, as it were, to the national government, the various national governments, and consider some of The other ways in which government in the 19th century was bigger than we might think. I have here a genuine replica of a $65 bill. Any takers? This actually precedes the 19th This was issued in 1779 by the Congress of the United States of North America and it promises to pay you 65 Spanish mill dollars. They weren't proud in those days. They weren't afraid to promise foreign money because everybody knew that the Spanish mill dollar was made out of gold and it had some value. So that's what they promised. Now this turned out to be quite quickly not worth the continental. But the point I want to make is that this

36:06is a, as it were, a piece of evidence of taxation. Because the Congress and the continental army and other people it was supporting, went out and exchanged these pieces of paper that they had printed up for goods and services. And getting the use of those goods and services constituted a tax because the people who got this in exchange, well the first people got a little something in exchange and next month after that the guy who held this got nothing approximately, because these things depreciated very, very quickly, and by the early 1780s, they were worthless. So the paper money issued by the United States and by the various states to pay for their Revolutionary War expenses, all operated as a tax by creating worthless pieces of paper and using them to acquire real goods and services. So it's the acquisition of real goods and services that was the tax and this is just the bookkeeping as it were for that Confiscation.

37:34I have another genuine replica here of another national government from the 19th century. This one was called the Confederate States of America, and it issued this bill, or at least the one it's a replica of on February the 17th, 1864 at Richmond, and it promises says that two years after ratification of a treaty of peace between the Confederate States and the United States, the Confederate States of America will pay to the bearer on demand $500. Well, we're still waiting for that treaty.

38:19We're waiting even more than the Koreans. They've only been waiting since 1953 for their peace treaty. We're waiting much longer for our peace treaty. So this was a vehicle of taxation. The Confederate states spent this money, and they got real goods and services in exchange. By this time, of course, the $500 of this bill would probably buy you about one potato, if that, Because the Confederate price level had gone up about a hundred times by then or close to it. So this was worth maybe five cents in gold.

39:08But it was still something and they were still printing them like crazy almost to the very end and using them as a means of taxation. It doesn't show up. Of course, none of these data reflect the Confederate states anyhow. Money issuance is another way in which, in the 19th century, governments at least periodically laid claim to resources and affected the way resources were allocated and used. Who got access to them? Who was able to do what? with the Power to Issue paper money had something to do with that now I have drawn a visual aid here believe it or not I sought a real map but failed to find one this morning so here we have approximately the the continental limits of the United States of America, and the point I want to make with this map is that it's a damn big area. When the United States came into existence, as I said a minute ago, nearly everybody who lived here, all four million of them, lived right here within a hundred

41:08But when the United States was created, and when the 13 original states ceded their land claims to the federal government, this, that would be the Mississippi River, the original area of the United States extended to the Mississippi River. And the states, most of them, had land claims all the way from the Atlantic out to the Mississippi. And in the 1780s, they ceded those claims to the government of the United States. So this huge area out here came into the ownership of the US government.

41:59Well, this is a magnificent resource. This is not the Sahara Desert. This is magnificent territory as territory goes on the face of the earth. It had great potential value once it had transportation access to the outside world so that people could get goods in and out cheaply. And as I indicated a while ago, they set about developing those means from the very beginning. So people began to move out there quickly, and when they did so, they needed to acquire the use of land, and the land was all owned by the United States.

42:44So what it meant was that the United States government might not have had much money in its treasury, but it had something almost as good, which is it had ownership of a huge amount of land of great potential value and so it began to use that land the way we think of modern governments using money to reward its friends, to carry out projects that it favors and so forth. Now, as I indicated yesterday, the governments want money to pay troops to kill people, if need be.

43:34That's the short course in public finance. Now, since they didn't have much money, and it was hard to get money that had any value for this government, they used land instead. Sometimes when they wanted to hire troops on for some expedition, they were always going to conquer Canada again, for example, they would promise people, as it were, look, sign up and when you get back, if you get back, we'll give you some land. And so every time there was a military expedition or a war, they would end up giving a land grant to the veterans and setting aside sometimes definite areas in the West that were reserved for the people who held these warrants, allow them a definite quantity of land.

44:34So this was a means of payment that they could use for anybody, including the services of soldiers, and they did this over and over and over, land grants to veterans. In addition, they made grants to states. Eventually this whole area was transformed into states, and as that happened, these states became players in the political process themselves. I indicated yesterday, for example, that the land-grant colleges of the 1860s were financed by the federal governments giving land claims to each of the states. So that even states which didn't have any public domain, such as the original 13, who never surrendered control of their lands, still got a claim to land somewhere in the West.

45:32West, and then they could turn around and sell that and use the money to establish their own land-grant colleges so that we get institutions such as Cornell University in New York a land-grant college even though New York had no public domain. So you could make land into a medium Museum of Exchange, as it were. You could finance schools. Indeed, in the original Northwest Ordinances, designed by, written by Jefferson in the 1780s, every township, every area six miles by six miles in the whole area of the United States west of the Appalachians, it is all divided into a grid, rectangular survey, so that you knew definitely where every line of longitude and latitude was, and it was all numbered in a way that you could organize and keep track of. You could locate any parcel of land in the whole United States with precision.

46:41According to this rectangular survey system, it really was a magnificent device for promoting In every township, which is six miles on a side, one of the sections, which is one square was reserved for common schools, which is to say public schools. So the people there could take that section, sell it, use the money to pay for the local school. So that was built into the land system of the country.

47:32Starting in 1850, the national government began to use land to subsidize major railroad projects. The first one was the Illinois Central, which brings us to the interesting topic of the President of the United States no one has ever heard of. And that would be Millard Fillmore. Has anyone ever heard of him? Well, this forgotten figure, in my mind, is best associated with his signing into law the land grant to the Illinois Central Railroad in 1850, and this was the first of what turned out to be many, many scores of land grants made by the federal government.

48:26And the Illinois Central connected, in addition to having some spur lines, Mobile, Alabama and Chicago, so more or less like that. This has lots of interesting stories associated with it. It was a very big business, I guess at the time it may have been one of the biggest enterprises ever undertaken in various dimensions, money and employees and the rest of it, but it was a kind of boon to a lot of local people too. Years ago I met some historians in Mississippi up in Oxford and they had been researching local court records and they discovered that the farmers in the county where Oxford, Mississippi When old cows got near death, they would haul it out and basically tether it to the railroad track.

49:34And then the Illinois Central locomotive would come along and smack Bessie. and then the farmers would carry her carcass to the local court and sue the railroad for the lost value of their cow and receive a very handsome reward by the local judge. So I don't know how many counties were engaged in this but I I wouldn't begin to assume that they were the only ones who had figured this out. Mississippi seldom the leader in thought.

50:26In Louisiana, we have a saying, that is, well, at least we're not Mississippi. But sometimes people write history as if these big corporations were just rapaciously running amok across everybody and that's a misreading because from the very beginning there was give and take. The great capitalists and the barons were not just doing their bidding. There was always a certain amount of resistance and fighting back and counter-exploitation, if you like. Now the Illinois Central received about two and a half million acres in its land grant.

51:17And it established the pattern for how these things would be done. And what would happen is that as the line ran along, in the case of the Illinois Central, they'd go back for six miles and every other section would be given to the railroad so that on this side it was the second one and so forth, like that. And it continued that way all the way down the line. Now the government retained all the alternating sections that weren't given to the railroad. Railroad, actually for I don't know if it was constitutional purposes or some other reason they actually made this grant to the states and then the states made the grant to the railroad so they may have been a kind of little bit of Jeffersonian strict constructionism still operative in the way they did that in 1850 but I know later they didn't do it that way in the 1860s and 70s but extended all the way down so the railroad got all this all this land which it could sell and the

52:34other sections the government retained and it sold and the idea was the government didn't lose anything because the railroad's construction and the bringing in of settlers would raise the value at least doubling the value of the plots that the government retained so they were giving away That was the logic, if you like, of the way they gave these alternating sections. Now in the 1860s, during the war, they made a much bigger land grant to two companies, the Central Pacific and the Union Pacific, which were built, one of them from Sacramento eastward and the other from Council Bluffs, Iowa westward, The Land Grants they got were 20 miles deep on each side of the track.

53:39Later on, the Northern Pacific Railroad got a land grant that extended 40 miles on each Each side of the track with all the alternating sections being given to the railroad. Now that turned out, all of those railroads actually turned out to pass through some pretty worthless territory and nobody ever wanted to buy a lot of those sections from the railroad so they still own them now. A great deal of land is owned by the Burlington Northern which is a corporate descendant of of the Northern Pacific Railroad, and a lot of it is managed in forests out in Montana and Washington State, and some of it still just sits there, never developed, but at all events these grants were used by the railroads to get revenue because they wanted to exchange The Land for Money, and they did sell a lot of it, and they promoted settlement, so they'd have customers to use their railroad, and all the big railroads of the late 19th century sent agents to Europe to tell immigrants about garden spots like Kansas.

55:02The Atchison, Topeka and Santa Fe had these posters showing Kansas, and they'd show all This poor bohemian guy, he sees this poster. Kansas, that looks great. Next thing you know, he's in Wichita saying, where's the orchard? Well, actually it worked out okay for a lot of them. There was an element of marketing run amuck here, but nonetheless a great many of these people, I don't want to pretend this was just a scam, because in fact a lot of people came to those railroad lands, bought them, settled them, lived on them happily and were better off for it.

55:54So let's give the devil his due here. In addition to making the railroad grants, the federal government made its land available to people who wanted to use resources there, even without their acquiring title to it. In the 1780s something called the Timber and Stone Act was passed and that was a law that allowed anybody to go on to federal land and cut down trees or take fallen timber if you want to use that for firewood or some other purpose or take stone for building so you could basically get construction materials without payment by just going on to federal lands and taking them.

56:421872. They also in that same decade passed a mining act, which allowed people to go on to federal lands and stake mining claims and exploit, build mines and exploit those mines and carry off the minimum wage tax.

57:12the minerals they took from them and make them, appropriate them, sell them, make them their own, and indeed that law is still in effect, and it's become quite controversial in recent years, but it's allowed thousands and thousands of miners in the west to go on to federal lands and build mines and exploit the minerals there without having to acquire and Engineering Ownership. So land was a big deal in the 19th century, very big. And it helps us to place in better perspective these budget data on the amount of money that the federal government had at its disposal because it was able to accomplish a great There are too many more objectives using its control of the public domain than it was by using the money it got from tax revenues.

58:18And to shape the way the country developed even, these big transcontinental railroads that were subsidized probably wouldn't have been built for decades, but for these subsidies. That means, of course, resources were being misused, but it also means that the country developed differently than it would have had the market been left to direct where resources were used. Sometimes these projects turned out to be reasonably successful afterward, almost by accident, even though market participants had evaluated them as bad prospects beforehand. But that was the exception to the general rule, and in almost all cases we'd have to say they were built too fast.

59:07They might have been sensible projects eventually, but not at the time they were subsidized and built. So we had the government, even when it wasn't misdirecting resources in place, it was misdirecting them in time. Well, the war between the states I've mentioned several times, and I want to come back to it just briefly now, because I've talked about how important state and local governments were in the 19th century, and how they were becoming even more important in terms of getting and spending money. But that's almost like a false signal of the way things were moving in the federalism of the United States.

1:00:00Because the Civil War, besides establishing all kinds of pernicious precedents for government activity and Taxing and Spending Money for Uneconomic Purposes and What Have You, changed the nature of the American political system forever. Before the war, the federal system had real content in the sense that the federal government could not just bully the states whenever it determined that it had to have them do something in a certain way.

1:00:47We know that because the states eventually just wouldn't put up with even being part of the system any longer, and 11 of them seceded from it. So it couldn't just bully them, but it could kill them. And so, it's like a Gordon Liddy's dictum, I like to repeat. Gordon Liddy says, you can't kill an idea, but you can sure kill the guy who holds it. So they couldn't kill the idea of federalism, true federalism, but they sure killed the guys who held that idea. And that settled the matter, because after 1865, nobody was really going to go out there and get killed by the hundreds of thousands for federalism anymore.

1:01:43That issue was settled here. Now when no state can secede, states are potentially, if not actually and immediately, nothing but administrative districts of the federal government. Doesn't mean they have no autonomy, and indeed there's enough life left in federalism that its various kicks and twitches still make it of some political interest even nowadays. But it's not the same system that it was before the war. Then it was genuine federalism. Since then it's been federalism at the pleasure of the central government. And as a result of that, we've had the enormous growth of the government that I'll be talking about later this week at the central level.

1:02:35If we had still had the old system of federalism, it's much less likely that the course of events would have taken that form, I think. Although it's very hard to say when we deal with hypotheticals of that magnitude exactly What might have happened, but I'm sure things would have gone differently. So the Civil War did make a difference even if it doesn't show up right away in such data as revenue distributions. Now, starting in the 1870s, thereabouts, the nature of the U.S. economy began to change in ways that were politically consequential.

1:03:23and I have in mind here the development of a national market and the development of big business. Before that time, there were almost no businesses in this country that employed more than a few hundred workers and very few that did business far from home in several states. But as the railroad network was developed and as technological changes proceeded in a number of industries, they had the effect of creating a potential for the realization of economies of scale.

1:04:12particularly industries in manufacturing that have kind of flow technology, things like petroleum refining or steel making or flour milling or even, although the flow is chunkier, meat packing. In industries that had a raw material flowing through a production process, it turned out that by increasing the size of the batches being processed, one could lower the unit cost of production. And so every time, for example, they built a bigger blast furnace to make steel, it turned out that they reduced the unit cost, the cost per ton.

1:05:02And this kept going for decades and decades. They just kept making them bigger and bigger. And every time they did it, there was a gain realized from doing it. and if you think about the geometry of it you can begin to understand why that was because the volume increases faster than the circumference of a vessel and so for among other things you didn't have to have twice as much volume containing a batch of steel in order to produce twice as a great an amount of molten metal so you kept about building these bigger and bigger processing apparatuses and every time you were able to produce cheaper and therefore to give customers a better deal than your competitors which compelled them to adopt that large scale technology and in some cases the market wouldn't support a whole bunch of large scale producers so the ones that didn't get there first do so the smartest went bankrupt and couldn't meet the competition.

1:06:14So there was, in a number of industries, there was technological change, growth of large-scale production, shake-out of small firms, you saw this especially in petroleum refining. In the beginning there were, I guess, thousands of petroleum refiners making little batches of Kerosene, and by the end of the 19th century there were only a few dozen maybe left doing business and most of them were the property of standard oil. So lots of big businesses developed. The first ones weren't batch technology operations, but they were the railroads. The railroads also turned out to be able to realize economies of scale by operating widely and starting in the 1850s they began to branch out.

1:07:11The first ones were only a few miles, maybe 20, 30 miles from one place to another and in the 1850s they built railroads from East Coast cities all the way out to Chicago. The Erie, the New York Central, the Pennsylvania Railroad, and the Baltimore and Ohio, all connected in East Coast City with Chicago, and talk about some fierce competition and some constant motive to cartelize. Those railroads had both. There's a really interesting book A book by Paul McEvoy written back in the 1960s, I guess, on the competition and cartelization for the trunk line railroads, the four I mentioned, and it's quite fascinating because he was able to study their rate wars and their attempts to cartelize and the conclusion of it of course is that all of their attempts failed fairly quickly. Railroads having this large-scale attribute and often getting boiled down to a handful of competitors were trying to form pools and cartels and conspiracies of some kind with great frequency and they always

1:08:37broke down. The question was how quickly, now you might say if they always broke down And what you want to remember is Stigler's dictum, the short run is long enough to get rich. So the motive was there, the incentive was there, they kept trying. There was actually a one railroad cartel among some of the railroads in the mid-south, upper south, The New Cartel seems to have worked fairly well in the late 19th century for over a decade. It was run by a man named Fink, of all things, and Fink was much envied in the railroad industry as having been able to devise a scheme that allowed him to run a successful railroad cartel, at least for a number of years, but most of the time they failed.

1:09:31Well, not only in railroads, but in many of these other new industries with big business, there were attempts to somehow suppress competition, which was normally quite fierce. And if there's one thing businessmen hate, it's fierce competition. And so they were attempting to find a way to suppress competition at the same time that other forces were constantly prompting them to compete. And in the 1880s, the lawyer for John D. Rockefeller's Standard Oil Company hit upon an innovation, the trust.

1:10:26And the trust was an ancient legal instrument which had been used to, say, set aside funds to support one's children or grandchildren or to support some hospital or college or something of that sort. Trusts of that kind had been around for centuries. So lawyers knew about them. But trusts had never been used for industrial purposes. But this clever fellow said, ah, tell you what let's do. We've got all these competing petroleum refiners and we're driving each other crazy. We're always keeping anybody from making profit for long because we just find ways to reduce costs and lower our prices and undercut the competitors and pretty soon nobody's making any money. It's just a treadmill. So, let's get off of this thing. Let's get everybody together. How are we going to do that? We know that you get people in a room and they all promise they'll hold a certain price and the next Today, they're cheating on it. They're making secret deals at lower prices to attract business.

1:11:42So how are we going to get around this? And the trust device was a mechanism by which the owners of the separate companies handed over their stock certificates to a group of of Trustees and they got in exchange a trust certificate, kind of gave them a membership in the central group, the trust, and of course by handing over their stock certificates they lost their voting rights, those came into the hands of the trustees. So Rockefeller are managed to persuade or intimidate or bully or somehow get everybody or a lot of the refiners to join the standard oil trust and at that point the trustees were able to make unified decisions about setting prices, about restricting supply, about closing down certain high cost Refinery and diverting production to others where they could produce at lower cost.

1:12:49This is known as rationalizing in business circles. So this worked out pretty well actually. It didn't mean that competition ceased because they never brought everybody into the trust and of course even if you did, some new company could start up. So it didn't solve their problem once and for all, but it did

1:13:43People began to refer to the trusts and to big business in general synonymously, so that even if you didn't form a legal trust, people began to call your company a trust because it was this big industrial organization. And so the anti-trust problem became, if not the The biggest issue, one of the two or three biggest political issues of the 1880s. Now, the people who put up the most squawk about this were, of course, the competitors who were suffering by virtue of the formation of big business, or in this handful of cases, the formation of actual trust organizations. And especially squawking were the butchers.

1:14:35In those days, before refrigeration, every town, every village, every neighborhood of every city in America had butcher shops. Because meat spoiled so fast, you had to slaughter the animals and use the meat right away. So there were butcher shops everywhere. There were probably hundreds of thousands of butcher shops in the country. And in the 1870s and especially in the 1880s, the big meatpacking companies in Chicago and a few other places like Kansas City and St. Louis and Omaha began to develop these mass production techniques to produce meat at very low cost and use refrigerated railroad cars to ship their product and keep it fresh and they could ship it anywhere in the U.S. because a week was no problem. In a week the railroad would take the product to the far ends of the country and it would get there, it would be as good or better than the local product and cheaper. So these guys began to drive local butchers out of business. Well, what

1:15:55What did they do? In neoclassical economics, when somebody can't meet the competition, he disappears from the industry. But in real life, when somebody can't meet the competition, he appears in the legislature. So they all appeared in the legislatures of all the states. And they said, these diabolical foreign trusts are coming into our market and driving perfectly really decent people out of their livelihoods. We can't allow that. It's not right. Now the consumers weren't complaining at all. Any trust was never a consumer-led movement. Never ever. Even where it has appeared in the past 130 years to have consumers involved, It's a fake. It's lawyers who pretend to be representing consumers.

1:16:53So it was always competing producers. And these butchers, because they were everywhere, were a political factor to be reckoned with. And so they showed up in the legislatures and they got a number of states to pass antitrust laws and health laws. Things that said, for example, no meat may be sold more than 24 hours after its slaughter in this state. Okay, I took care of the imported product. Or you could devise all kinds of other pseudo health rules. This is a game that's still played. Europeans do this all the time to keep competing agricultural products out of their markets.

1:17:39The markets, and the Americans do it too, they for years wouldn't let Argentine beef into the country because it was said to be potentially infected with foot and mouth disease, as if you couldn't check or leave it up to the consumers to take the risk if they cared to, but at all events these butchers were a mighty political movement. Now, when a number of states began to suppress the competition of the big meatpacking companies, these guys had some clout too, and so they began to lobby in the state legislatures. But worse yet, it turned out that they could threaten that they actually would stop coming into the state.

1:18:30And then that meant that a whole bunch of people who had discovered they liked this product and wanted to consume it were in trouble again, and furthermore, the business could just move out, abandon the state and go somewhere else, and states never like to lose taxable resources, so there were counter pressures being put on by the big companies and the issue was carried to the Congress of the United States. We begin to see here what I referred to earlier today enigmatically as federalism containing the seeds of its own destruction.

1:19:18You've got all these states and every one of them has regulatory power. So they use it, it's political hay to be made by exerting their power as Fred McChesney expresses it, you know, they use extortion. A lot of times when you appear to see business paying a bribe, it's not a bribe, it's a The shakedown. State legislators or officials go to companies and they say, you know, pay us off or we will hurt you by the way we employ our regulatory powers. So when that happens, companies operating in many different states find themselves caught often at the mercy of having to comply with not only a lot of regulations but different ones, Which makes it very difficult for them to do their processing or labeling or even to decide how to construct their product.

1:20:20And so businessmen, always having the amount of foresight that extends slightly beyond their nose, are always looking to put out the fire that's burning them at the moment. And the way they respond to being whipsawed by the different states is by saying, let's Let's get one regulatory agency, and we can deal with that better, cheaper. Maybe we can even control it, if not right away, then eventually. And this has happened again and again and again in American history. States, you know, we all think states are wonderful, they give us some place to run to when our own gets too onerous. And that's true, there's something According to that, there is Tebow-type competition, as economists call it, but there's also this dark side of federalism, which is that it drives regulated companies to seek one regulator, and that, of course, is the national government, the government that, using the power to regulate Interstate Commerce can, under the Constitution, get away with regulating companies who do business in more than one state.

1:21:41And so that's how we got the Sherman Antitrust Act of 1890. It wasn't as bad as some people think, actually, because the common law had been dealing with monopolies and restraints of trade for a long time and judicial doctrines had evolved that were not unreasonable. Fundamentally what they boiled down to was the idea that it's unlawful for you to take actions that keep somebody from coming into a market to compete but otherwise if you want to make agreements about how to use your property, Even if you want to get together with other producers and set a reasonable price, price fixing, that's also legal.

1:22:31We don't object to that in the court. In the beginning, the idea was that all the Sherman Act had done was to codify the common law and to add the punishment that allowed treble damages to be paid to private plaintiffs who succeeded in a case brought under that law for charging someone with conspiring or contracting to operate in a restraint of trade or to operate a monopoly. That language seems vague and a lot of economists especially have looked back and said, Well, it didn't say anything. It's so vague. What does it mean? But it meant something at the time in the courts. There's a very good book by Martin Sklar, even though Sklar is a kind of Marxist.

1:23:25He's an excellent legal historian, and a big section of his book deals with the evolution of the jurisprudence of the Sherman Act, and it's outstanding. I don't know anything that can compare to it. and explains that until about 1897, the Supreme Court continued basically to read the Sherman Act as if it was nothing but a codification of the common law. But in 1897, in a case called Trans-Missouri Railroad, it changed its reading, and at that point it began to act as if the Sherman Act had not codified the common law, Law, but it overturned it and replaced it with a rule that required absolutely no price fixing and no variety of other measures businesses might enter into to cooperate or act in a way that restrained competition.

1:24:28It was no longer read simply as having to do with keeping new entrants out of the market. That created a lot of uncertainty for business at a time when big business was developing quickly. It made, among other things, big businesses subject to shakedowns by Theodore Roosevelt after he became president in 1901. Teddy, as you may remember, didn't oppose big business, only bad big business. That was the big business that didn't play according in his Rules. So he would even turn on his pals like Morgan and Company and go after the Northern Securities Company that Morgan had formed in 1903, I guess it was, and had that broken up without even discussing it with Morgan.

1:25:21Morgan was outraged. He said, if we had a problem, why didn't you send your man to talk to my man? That's the way they normally took care of things in those days and, of course, still do in some circles. That's called Trans-Missouri. Trans-Missouri had to do with a freight company. But that kind of legal uncertainty about the Sherman Act persisted until 1911. And in 1911, when the US Supreme Court ruled on the American tobacco and standard oil cases, which had been in the courts for years and years before a final decision was reached, the court announced what came to be known as the rule of reason.

1:26:08And that was a little more accommodating rule in the sense that it said mere bigness is not a crime. And furthermore, there are reasonable kinds of contracts and arrangements that businesses can enter into, which may have the effect of in some way restraining competition, but they're not unlawful nonetheless. And furthermore, if you acquire your position in the market, even if it's a very large market share, by purchasing other assets, that's okay. So if, for example, you just merged with a lot of other competing companies, that was not unlawful under the 1911 ruling. Or if you're just such a well-run company that you just got bigger and bigger and bigger and eventually you had almost all the market, that also was permissible.

1:27:02So this was a rule that gave more latitude to big business and clarified some of the uncertainty, But, of course, antitrust law has continued to be a kind of cloud hanging over many business people. They never are quite sure when it's going to be used as a club by their competitors to, if not to really stop them, to harass them and make them expend a lot of money on lawyers. And we've seen that again and again and again in the past century. So, we got this development of big business, national markets, antitrust law, and in 1887, the first federal regulatory agency of any consequence, the Interstate Commerce Commission, which became more powerful in the early 20th century with amendments to the law, and ended up virtually setting railroad rates and other terms of service, and pretty much ruining the railroad industry by the time World War in 1921 started, at which time the railroad system got so snarled up thanks to its previous ruination and bad planning by the war planners that the Federal Government nationalized the

1:28:23industry in 1917 and operated it on its own account for several years before giving it back to the owners with many strings attached in 1920. So we're almost out of time. I've gone on a long time, but we have a few minutes for questions still. Yes? Regarding the railroad, when was Amtrak created? What year? Seventy... Seventy, was it? 1970? That's about right. Early 70s sometime, I remember. Brad? These new state constitutions in the 40s that were sort of in response to the Wildcat Banking and the debacle, did they just get around the wording by giving subsidies directly to private businesses instead of having the state do it themselves? Is that what happened?

1:29:34So they just kept them from doing certain enterprises themselves?

1:29:54Is that where we get today where the states can't run deficits like the federal government can? The origin of those provisions or not, I'm just not sure when they appeared in the state constitutions, but I believe there are still a few states today that don't have that provision. I was under the impression until recently that they all required balanced budgets. Now, they've all devised ways to escape that constraint with off-budget gimmicks and with borrowing of various sorts, but it's still a serious constraint for state governments because they can't get around it so easily as the federal government, which doesn't have any constraint at all of that sort.

1:30:47Some of those state constitutions also prohibited private banks from issuing paper money too, like the New England state, southern state, southern state. The soundest banks in the country in the antebellum period were in New Orleans, and although Louisiana did regulate banks to some extent, they were not much regulated. They were just well-operated banks. They issued bills that circulated widely all over the South and I suppose many of you know that's why the South is called Dixie because Louisiana still used the French language in those days and when they printed a $10 bill it said Dixie.

1:31:37And to an Anglo, it was Dix. So the area where these kinds of bills circulated around was Dixie, after the $10 French-language New Orleans bank paper money. Do you think that had something to do with the way that law in Louisiana was structured differently than in other states, that banks were more sound? Well, in part it had to do with that. Some of the states still had pretty bad banking law and some had more regulation than others. It's very hard to generalize about state banking laws before the Civil War because they varied a great deal from one state to another. But all the states did, to some extent, back away from conducting banking business.

1:32:26Business. As I say, some were still doing it in the Midwest and after the Civil War even. I think that was one of those activities that legislators ultimately discovered that they could do better by using indirect means rather than direct means, just as they did when they adopted general incorporation laws rather than passing a special act of the legislature Every time they created a corporation, eventually it just got to be a hassle, because thousands and thousands of guys were coming into the legislature wanting to form a corporation and they didn't want to be bothered anymore, so eventually all the states passed laws which set general conditions for conducting corporate business and all you had to do was fill out the forms and pay a usually nominal fee and you were off and running.

1:33:22In most cases it was, the earliest general incorporation acts were in the second decade of the 19th century and I think by about 1880s all the states had some form of general incorporation in effect. I myself am a corporation now, but you know, only to kind of jack up my self-esteem. An S corporation in my case. I'll let you figure out what the S might stand for.

1:34:13Pretty good to have lunches and munches of those banks.

1:34:43And they created that system. It had nothing to do with a uniform currency or any of the publicly proffered excuses for it. It was just another way that the Union government tried to float debt.