Government subsidies distort the market

In a post about shilling for environmentally friendly energy subsidies, Radley Balko touches on one of the biggest boondoggles of the 19th century, the building of the Union Pacific and Central Pacific railroads:

In 1862, Congress justified passing the Pacific Railroad Act as a way to forestall a secessionist movement in California during the Civil War. The government subsidized the Union Pacific and Central Pacific railroads at $16,000 per mile over an easy grade and up to $48,000 in the mountains. In addition, the government offered substantial land grants along the right-of-way. Despite these government subsidies, both companies were bankrupt in the early 1870s.

As an example of how government subsidies distort incentives, both railroad construction crews worked past each other building an extra 200 miles of parallel rail lines grades (and some parallel tracks) instead of linking up so their companies could earn more subsidy payments and land grants. The fact that government subsidies were not necessary for building a transcontinental railroad was proved when James J. Hill built the highly profitable Great Northern Railway from Minnesota to Seattle completely without them or land grants.

The UP/CP are an excellent example of how injecting government money into what should be a private endeavour will seriously distort the market, creating a huge incentive to "game the system" to maximize the unearned profits from the government, rather than by serving the public by actually running a business.

If you've read any of the histories of the Union Pacific¹, you'll very quickly discover that the company spent far more time and effort lobbying for subsidy, manoevering against potential competitors (by legislation, bribery, and political obstruction, not by actually serving their customers), and hiding the mind-boggling levels of waste, corruption, and incompetence of their day-to-day operations.

That's not to minimize the difficulties of actually building and running the railroad, which cost the lives of many men (disproportionally immigrant Irish and Chinese labourers), but the fact is that the railroad itself was a very distant second to the government largess to be diverted for private profit by the executives of the two corporations. The excesses and criminality of the various officers of the company had an even more important legacy: after the scandal broke, leaving both companies bankrupt, successive governments felt totally justified in heavily regulating all railroads, introducing economic burdens which would cripple most of them for nearly a hundred years (some of the worst regulatory burdens weren't lifted until the 1980's²).

^1. Except for the sanitized versions produced for children, which only cover the engineering achievements, not the grubby reality of the UP & CP in their early years.

^2. See the Staggers Act for information on the deregulation which belatedly allowed the revitalization of the American railroad industry.

Studies of the rail industry showed dramatic benefits for both railroads and their users from this alteration in the regulatory system. According to the Department of Transportation's Freight Management and Operations section's studies, railroad industry costs and prices were halved over a ten year period, the railroads reversed their historic loss of traffic (as measured by ton-miles) to the trucking industry, and railroad industry profits began to recover after decades of low profits and widespread railroad insolvencies.