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THE TARIFF

The centerpiece of Henry Clay’s plan for the industrialization of the United States had been a high protective tariff (Hamilton had preferred government subsidies to infant industries).

Lincoln told a correspondent in 1859, “I was an old Henry-Clay-Tariff Whig. In old times I made more speeches on that subject than any other. I have not since changed my views.”
³⁴
Throughout his political career, Lincoln seemed to illustrate the definition by a contemporary in protectionist Pennsylvania of man as “an animal that makes tariff speeches.”
³⁵
Early in his career, Lincoln had worn a suit of homespun jeans as a legislator, in emulation of George Washington’s decision to dress in homespun for his inauguration, encouraging the spirit later manifested in “Buy American” campaigns. In arguing for a protective tariff, Lincoln followed Clay in identifying industrial Britain as America’s economic rival, and claimed that those who purchased imported British goods were unpatriotic snobs: “Those whose pride, whose abundance of means, prompt them to spurn the manufactures of their own country, and to strut in British cloaks, and coats, and pantaloons, may have to pay a few cents more on the yard for the cloth that makes them. A terrible evil, surely, to the Illinois farmer, who never wore, nor never [
sic
] expects to wear, a single yard of British goods in his whole life.”
³⁶

The tariff was part of the Republican Party platform of 1860, whose wording, the product of the efforts of Henry Carey among others, sought to please every constituency: “While providing revenue for the support of the general government by duties upon imports, sound policy requires such an adjustment of these imports as to encourage the development of the industrial interests of the country; and we recommend that policy of national exchanges, which secures to the working man liberal wages, to agriculture remunerative prices, to mechanics and manufacturers an adequate reward for their skill, labor, and enterprise, and to the nation commercial prosperity and independence.”
³⁷
One observer reported: “The Pennsylvania and New Jersey delegations were terrific in their applause over the tariff resolution, and their hilarity was contagious, finally pervading the whole vast auditorium.”
³⁸
The electoral votes of protectionist Pennsylvania and New Jersey were crucial in helping Lincoln and the Republicans win the White House in 1860. “Protection made Mr. Lincoln president,” Carey said.
³⁹

After he had been nominated as the Republican presidential candidate in 1860, Lincoln took part in a parade in his hometown of Springfield, to which the contribution of the local woolen mill, according to one historian, was “an immense wagon containing a power loom driven by a steam engine. Several yards of jean cloth, from which a garment was fashioned for Lincoln, were made as part of a demonstration. The wagon bore the significant motto ‘Protection to Home Industry.’ ”
⁴⁰

In May 1860, before the election, the House had passed the Morrill Tariff, which was passed by the Senate between Lincoln’s election and his inauguration. Tariffs were raised again during the Civil War in 1862 and 1864. The administration of Abraham Lincoln inaugurated an era that lasted until World War II, in which the United States had the most protected home market in the world. Between 1867 and 1914, while many goods were admitted free from duties, the US tariff on dutiable imports, chiefly manufactured goods, hovered between 40 and 50 percent.
⁴¹

From Ulysses S. Grant to Herbert Hoover, Lincoln’s Republican successors shared his view that the government should protect and promote American manufacturing. President Grant pointed out that Britain had industrialized behind a wall of protective tariffs, turning to free trade only when its manufactured exports were superior to those of other countries: “After two centuries, England found it convenient to adopt free trade because it thinks that protection can no longer offer it anything. Very well, Gentlemen, my knowledge of our country leads me to believe that within 200 years, when America has gotten out of protection all that it can offer, it too will adopt free trade.”
⁴²

William McKinley, who published a book on the tariff, succeeded Justin Morrill as the leading spokesman for protectionism in the Republican Party and gave his name to the 1890 McKinley Tariff. McKinley and his vice president and successor, Theodore Roosevelt, recognized the need for reciprocal trade liberalization in sectors where infant industry protection had successfully created mature American industries. But like other Republicans of their time, they remained committed economic nationalists. Roosevelt wrote in 1895: “Thank God I am not a free-trader. In this country pernicious indulgence in the doctrine of free trade seems inevitably to produce fatty degeneration of the moral fibre.”
⁴³

The US model of import substitution became a model for other industrializing countries like Germany, Japan, Russia, and the British Dominions of Canada, Australia, and New Zealand. In the early twentieth century, the economist Frank W. Taussig, despite his commitment to free trade, conceded that without protectionism the development of American manufacturing might not have taken place as rapidly as it did.
⁴⁴
Whether because of or in spite of protectionism, the US economy grew at 4.1 percent a year from 1870 to 1913, while free-trade Britain grew at only 1.9 percent a year.

THE WHARTON SCHOOL OF PROTECTIONISM

Before the Civil War, economics was taught as a part of moral philosophy, a subject that also included politics and ethics. University teachings on trade generally reflected the interests of the local business elites who served as university regents. Free-trade theory was taught in the cotton-exporting South and the commercial and financial Northeast. Pennsylvania, the center of American manufacturing, naturally became the center of protectionist economics.

Joseph Wharton was the patrician heir of a Philadelphia Quaker family that had made its fortune in real estate and trade. Wharton made a fortune of his own in mining and smelting industrial metals such as iron and later steel, lead, and zinc. He attended the economist Henry Carey’s salon in Philadelphia and belonged to the Industrial League and the American Iron and Steel Association. Wharton viewed free trade as a “fungus . . . which healthy political organisms can hardly afford to tolerate.”
⁴⁵

In 1881, in order to promote protectionism, Wharton founded the first business school in the United States. In his deed of gift to the Wharton School of Finance and Economy at the University of Pennsylvania, the industrialist specified that the school should teach “how by craft in commerce one nation may take the substance of a rival and maintain for itself virtual monopoly of the most profitable and civilizing industries; how by suitable tariff legislation a nation may thwart such designs.”
⁴⁶
He made his gift conditional: “the right and duty of national self-protection must be firmly asserted and demonstrated.”
⁴⁷

A disciple of Carey named Robert Ellis Thompson, who became the first American professor of social science in 1874, helped to found the Wharton School. Thompson’s book
Social Science and National Economy
, financed by Wharton, became the basis of instruction in economics.
⁴⁸

In 1883, leadership of the Wharton School was taken over by Edmund J. James, a German-trained scholar who was inspired by Germany’s
Verein fur Sozialwissenschaft
, an organization that promoted policy-relevant research, to found the American Academy of Political and Social Science in 1889 and the National Municipal League in 1893. Another economist trained in the German historical school, Simon Patten, taught at Wharton and defended America’s Hamiltonian import-substitution policy in
The Economic Basis of Protection
.
⁴⁹

By the early 1900s, many US industries no longer needed infant-industry protection, while German-trained academics were more interested in progressive and socialist causes. The result was the purging of progressive scholars by business-dominated boards of regents in the first decades of the twentieth century.

“THE CRIME OF 1873”—THE RETURN TO THE GOLD STANDARD

Manufacturers were only one constituency in the Republican Party. Republicans in finance and import businesses shared the traditional antipathy of those sectors to protectionism and put great value on the gold standard, as it was adopted by most of America’s trading partners in the second half of the nineteenth century.

Following the conclusion of the Civil War, the New York financial community, eager to resume its role as intermediary between the cotton growers of the South and the British and European textile industries, favored a lenient approach to Reconstruction that would facilitate the resumption of cotton exports as quickly as possible. President Andrew Johnson, who was dreaded and despised by the Radical Republicans who later unsuccessfully impeached him, was lionized by the New York elite when he visited the city in the summer of 1866. Earlier, in the spring of 1865, the Chamber of Commerce of the State of New York declared that Reconstruction should not “be condemned as needlessly harsh or revengeful by the cool judgment of the humane and liberty-loving in any part of the civilized world.”
⁵⁰
New York’s financial community was appalled when, in his final annual message to Congress in December 1868, Johnson reverted to his populist roots and proposed to confiscate the interest owed to federal bondholders and use it to pay down the federal debt.
⁵¹

After many Democrats proposed repaying federal creditors in inflation-depreciated greenbacks, it became a point of honor for Republicans to insist that holders of federal bonds be repaid in gold. In the Public Credit Act of 1869, Congress declared its support of a gold-backed currency.

Within the Republican Party, however, greenbackers could be found. Support for fiat money, like support for a powerful, activist federal government, was concentrated in iron-producing and manufacturing areas like Pennsylvania and newly settled midwestern and western regions that wanted government-sponsored infrastructure development.
⁵²
Carey and other members of the Pennsylvania protectionist wing of the Republican Party favored greenbacks, because they had the effect of devaluing the US currency, to the benefit of American exporters and the detriment of British and European manufacturers who sought to sell in the United States.
⁵³
For the same reason, William McKinley, who represented midwestern manufacturers, preferred what was called “Buckeye Bimetallism” (after Ohio, the Buckeye State) to a pure gold standard during the presidential campaign of 1896, notwithstanding William Jennings Bryan’s claim that McKinley and the Republicans sought to “crucify mankind upon a cross of gold.”

THE HOMESTEAD ACT AND THE LAND-GRANT UNIVERSITY SYSTEM

Another important Republican constituency was made up of free farmers in the North. Many Republican agrarians had been Jeffersonian and Jacksonian Democrats, who joined the Republican Party out of fear that the expansion of slavery into the West and North would force them to compete with slaveowners for land or with slaves for jobs.

The Homestead Act, passed by Congress in 1859, was a concession to the former Jacksonian Democrats in the Republican Party. The law gave 160 acres to anyone who would live on the land and work it for five years. President James Buchanan, an ally of the southern slaveholding elite, vetoed the Homestead Act but it was passed again by Congress and signed by President Lincoln in 1862. The purpose of the act was thwarted to some degree by the success of railroads, other corporations, and rich investors in obtaining lands intended for settlers. Even so, more than half a million farmers received a homestead by 1900 (the act was repealed in 1977). The Morrill Land-Grant Act of 1862 provided every state with grants of federal land to pay for establishing state agricultural and mechanical colleges (A&Ms). Intended to provide a liberal education for rural Americans, the A&Ms were given a new and important role in scientific agricultural research by the Hatch Act of 1887, which established a network of agricultural experiment stations for America’s oldest major economic sector.

THE SECOND REPUBLIC

The Civil War and Reconstruction replaced the First Republic of the United States, dominated for most of its existence by southern slaveowners, with a Second Republic dominated by the industrialists, financiers, and free farmers of the Northeast and Midwest. Alexander Hamilton’s and Henry Clay’s vision of developmental capitalism, not the adversarial, small-producer capitalism of Thomas Jefferson, shaped the economic policies of Abraham Lincoln and his allies.

The Lincoln Republicans saved the Union, freed the slaves—and freed the remarkable powers of industrial capitalism from subordination to an agrarian oligarchy, the southern planters. But like many newly industrializing countries, the United States after the Civil War sacrificed social justice and resource conservation to the imperative of economic growth. With harmful effects as well as good, the transformation of the American polity by the technologies of the first industrial revolution was under way.

We have all heard of Young America. He is the most current youth of the age. Some think him conceited, and arrogant; but has he not reason to entertain a rather extensive opinion of himself? . . . The iron horse is panting, and impatient, to carry him everywhere, in no time; and the lightning stands ready harnessed to take and bring his tidings in a trifle less than no time. He owns a large part of the world, by right of possessing it; and all the rest by right of wanting it, and intending to have it.

—Abraham Lincoln, 1859
¹

F
ifty-six miles west of Ogden, Utah, on May 10, 1869, the first of five transcontinental railroads was completed by a ceremonial golden spike that connected the Union Pacific and Central Pacific Railroads. Authorized by Congress in 1862 with the Pacific Railway Act, the transcontinental railroad linked the East and West. The North and South had already been riveted together in the Civil War of 1861–1865, with bullets and cannonballs.

As early as the 1830s, Americans discussed a transcontinental railroad. To facilitate a southern route, in 1853, a strip of land called the Gadsden Purchase was bought from Mexico and added to the former Mexican territories acquired by the United States after the United States–Mexican War. But rivalries between the North and South in Congress blocked agreement on a route.

The departure of southern representatives from the House and Senate during the secession of the southern states freed Congress and the Lincoln administration to charter two railroads with the Pacific Railroad Act that President Lincoln signed on July 1, 1862.

The bill chartered two companies, the Union Pacific and the Central Pacific, to connect Omaha and Sacramento. The Pacific Railroad Act authorized the Union Pacific to go west from Omaha, while the Central Pacific would go east from Sacramento. Each line was given twenty alternate sections of federal land for each mile built. The Union Pacific received twelve million acres of land and $27 million in government mortgage bonds, the Central Pacific nine million acres and $24 million in bonds. Later, the Texas Pacific received eighteen million acres and the Northern Pacific forty-four million acres. The two railroad companies raised additional private funds in the United States and Europe.

The Central Pacific broke ground in January 1863 in Sacramento, California. In December of the same year, the ground breaking of the Union Pacific took place in Omaha, Nebraska. The race to lay rails across the continent had begun.

Each railroad faced different kinds of obstacles. The Central Pacific had to grade and blast its way over the mountains. The Union Pacific, crossing the level Great Plains, was attacked by Sioux and Cheyenne Indians who were threatened by the invasion of their territory. At Plum Creek, Nebraska, Cheyenne warriors derailed and looted a freight train. Forts were established along the route and the workers were armed.

The workers who built the first transcontinental railroad included northern and southern veterans of the Civil War and freed slaves. The Union Pacific relied heavily on Irish immigrants, the Central Pacific on Chinese contract workers.

The tracks met in the Promontory Mountains in Utah. As delegates arrived to celebrate the project’s completion, the target date of May 8, 1869, was missed. On May 9 the final twenty-five hundred feet of track were laid. On May 10, two trains, the Union Pacific’s Number 119 and the Central Pacific’s
Jupiter
, stood facing each other. A little after noon an official from each company used a silver sledgehammer to tap ceremonial gold spikes into the final tie. A signal flashed across telegraph wires to bring the news to the rest of the country: “Done.”

In seven years the Union Pacific had built 1,086 miles of track, while the Central Pacific had built 690 miles. The Great Plains were opened to settlement, at the expense of the Plains Indians, who in the succeeding decades were confined to reservations. Before the transcontinental railroad, overland travel to the Pacific coast of the United States had taken months, as had the alternatives of sailing around the tip of South America or sailing to Central America, crossing the isthmus and boarding another ship. Now it was possible to travel from the East to the West Coast in less than a week for a fraction of the price.

RUINOUS COMPETITION

The railroad industry was America’s first big business. Not until the late nineteenth century did giant corporations emerge in many manufacturing and retail industries. Until then, production and distribution tended to be carried out by relatively small shops and stores.

In 1896, the railroad industry accounted for 15 percent of gross national product, more than federal, state, and local governments combined.
²
The investment of $188 million in canals between 1815 and 1860 was dwarfed by the $1.1 billion invested in railroads between 1830 and 1859.
³
Until the end of the nineteenth century, railroad stocks and bonds dominated the American stock market. Around 1870, 50 percent of America’s capital goods industries and 10 percent of its nonfarm labor were contributing to railroad construction.
⁴

The railroad industry was afflicted by a problem that later injured a number of large-scale industries with increasing returns to scale—the problem caused by the gap between fixed costs (repayment of borrowing to build the physical structure) and variable or operating costs. The fixed-cost problem meant that the traditional answer to monopoly—increased competition—could not work and indeed would make matters worse. If a railroad was challenged by a rival line, the resulting price war could doom both the incumbent and the challenger to bankruptcy.

In addition to fixed costs, the railroad industry was characterized by network effects. A railroad line between only two cities would suffer if the economy in one declined. In contrast, regional networks including many points were more stable than local systems, and national systems had the greatest stability of all.

Britain permitted railroads to engage in cartelization and prohibited mergers, in order to avoid consolidation while enjoying the benefits of coordination.
⁵
In France, with its tradition of administrative guidance of the economy, the government supervised management, regulated rates, and arranged mergers. Most European governments engaged in public rate setting, prohibited construction of competing lines, and enforced private cartels in the courts. By 1945, every major country in the world except for the United States, with the exception of the Wilson administration’s nationalization of the rails during World War I, had nationalized its railways.

In the United States, however, the Jeffersonian tradition of localism and laissez-faire dominated during the period of railroad construction between the Civil War and the 1890s. The result was massive overbuilding—by the 1880s the country had nearly twice as much track as it needed—and chronic bankruptcy: in the 1870s, nearly 40 percent of American railroad bonds were in default.
⁶
In 1895, one-fourth of American railroads were in receivership as part of bankruptcy proceedings.
⁷
Waves of bankruptcy in turn resulted in the consolidation of the railroads into a few networks by the early twentieth century. William Vanderbilt, an heir to Cornelius Vanderbilt and a railroad owner, predicted accurately that the alternative to government-sanctioned pooling would be the absorption of small firms by large railroads.
⁸

Not until the early twentieth century did economists and public officials acknowledge the inapplicability of competitive market economics to railroads.
⁹
The Transportation Act of 1920 permitted pooling by railroads subject to regulation by the Interstate Commerce Commission. Until 1980, the railroads were a consolidated, nationally regulated public utility. Following the deregulation of the railroads by the Staggers Act of 1980, the American railroads were quickly consolidated into a few private regional monopolies.

TRANSCONTINENTAL CORRUPTION

Ironically, the corruption associated with the construction of transcontinental railroads was the result of a system adopted in the hope of avoiding corruption. Direct federal construction of transcontinental railroads was rejected because, in the words of President James Buchanan in his annual message on December 6, 1858, government railroad construction “would increase the patronage of the Executive to a dangerous extent, and introduce a system of jobbing and corruption which no vigilance on the part of the Executive could either prevent or detect.”
¹⁰
Another alternative, a private monopoly chartered by the federal government, was rejected in 1851 when the railroad promoter Asa Whitney asked Congress to provide him land grants for a railroad to the Pacific.
¹¹

In its final form, the Pacific Railroad Act that President Lincoln signed on July 1, 1862, was intended to minimize the possibility of corruption. The act provided that the railroads would receive federal lands only after the tracks were built; time limits were imposed; the railroads had to acquire sufficient private capital of their own, before using federal eminent-domain authority; and the twenty-member boards of the railroads included five government directors apiece.
¹²

But greed found a way. In return for stock that they received in blatant violation of the bill itself, the government directors of the railroad companies looked the other way. While serving in Congress, Oakes Ames of Massachusetts, who with his brother owned one of the country’s biggest shovel manufacturing companies, sat on the boards of the Union Pacific and its construction company, Credit Mobilier. Ames bribed many members of the House, Senate, and executive branch with company stock in return for their support of legislation favorable to the corporation, like an 1864 law that doubled the land that the Union Pacific received and made the federal loan guarantees more favorable.
¹³

Credit Mobilier charged the Union Pacific two or three times the actual cost of construction. The Union Pacific also used other front companies, including the Wyoming Coal and Mining Company, which sold the coal to the railroad at three times the real cost. There was no similar scandal involving the Contract and Finance Company, the Central Pacific’s equivalent of Credit Mobilier, because the financial records of the Central Pacific’s construction company conveniently disappeared.

In the wake of these scandals, Congress refused to charter any more railroads, following its charter of the Texas and Pacific in 1871. The corruption associated with the transcontinental railroads that were supplied with federal land grants and other aids is often invoked by those who argue that government promotion of infrastructure and industry is inherently flawed. “Never heard of the Great Northern?” Bill Frezza of the Competitive Enterprise Institute wrote in
Forbes
in September 2011. “That’s because they don’t teach about it in government schools. That transcontinental railroad, completed in 1893, was the only one built entirely with private money on privately purchased land, by a self-made railroad tycoon, James J. Hill. . . . Many believe Ayn Rand got her inspiration for Taggart Transcontinental in her novel
Atlas Shrugged
from the Great Northern.”
¹⁴

In reality, Hill’s Great Northern depended as much on government land grants as the other transcontinental railroads. When they purchased the St. Paul and Pacific Railroad, which had gone bankrupt in the panic of 1873, Hill and his partners purchased the assets, which included a 2.5 million-acre land grant from the state of Minnesota. Out of seventy-five land grants given to American railroads between 1850 and 1871, Hill’s government land grant was the seventh largest.
¹⁵

“THIRTEEN MILLION DOLLARS IS ALSO SOMETHING”

The centrality of railroad issues on Wall Street quickly led to the emergence of a breed of speculators who were interested only in gaming railroad stocks to make quick money. The most celebrated stock market struggle of the period was what became known as the Erie War.

In 1868 “Commodore” Cornelius Vanderbilt, having moved from the steamship business into the railroad industry, sought to take over the Erie Railway Company, which was the main rival of his own New York Central Railroad. What was at stake was control of the railroad traffic between New York City and the west.

The Erie was run by the seventy-one-year-old Daniel Drew. In
Chapters of Erie
, Charles Francis Adams, the son of John Quincy Adams and a railroad president in his own right, wrote: “Drew sought to carry to a mean perfection the old system of operating successfully from the confidential position of director, neither knowing anything nor caring anything for the railroad system, except in its connection with the movements of the stock exchange, and he succeeded in his object.”
¹⁶
Unlike the patrician Adams, and like his rival “Corneel” Vanderbilt, “Uncle Dan’l” was a self-made entrepreneur who observed: “Book learning is something, but thirteen million dollars is also something, and a mighty sight more.”
¹⁷

Drew’s allies on the Erie board included James Fisk and Jay Gould, both in their early thirties. Fisk, plump and outgoing, was a former circus worker and peddler who had smuggled cotton from the Confederacy into the North during the Civil War. The thin and introverted Gould was a sickly individual from a family of poor farmers in New York who had become a master speculator. When Vanderbilt’s agents tried to buy up controlling shares of Erie stock, the Commodore discovered that Drew, Gould, and Fisk secretly printed millions of dollars worth of new bonds in order to thwart the takeover bid. However, Vanderbilt arranged for a compliant New York judge named George Barnard, who belonged to the Tweed Ring run by the notoriously corrupt William “Boss” Tweed, to rule that the Erie directors had violated an injunction. In response, Drew, Fisk, and Gould fled to New Jersey, where friendly judges would shield them, and made their refuge, Taylor’s Hotel, into “Fort Taylor.”