It’s widely understood that railroads advanced the United States and its economy. In the 1800s, newly built railways ferried passengers and freight over mountains and across the industrializing country, shaping commerce in the process and helping make the US a global power.
And yet historical assessments may have vastly underestimated their true economic impact, according to Chicago Booth’s Richard Hornbeck and NYU’s Martin Rotemberg.
That’s because the changes brought by the railroads took place in an inefficient economy, hampered by monopoly-power pricing, legal uncertainties, poor regulation, and credit constraints, they write.
“Market distortions magnify the impacts of technologies or infrastructure,” Hornbeck and Rosenberg write. “Potential economic gains are largest when the economy is most inefficient; that is, with great problems come great possibilities.” This, they point out, is relevant to the effects of technology and other economic stimuli today.
Railroads are popularly understood to have lifted the US economy in the second half of the 19th century, freeing producers from their reliance on waterway networks and high-cost wagon transportation. However, calculations have suggested rail had only modest effects. For example, the late Robert W. Fogel, a Nobel laureate, argued that railroads’ aggregate impact on US agriculture was small overall because rail provided only modest cost savings over waterways along many popular routes. The methodology Fogel used “has been widely applied to transportation improvements and other technological innovations,” note Hornbeck and Rotemberg.
They developed a different methodology to measure aggregate impact, one that takes into account gains through increased market access in places. Yes, you can gauge the effects of railroads by looking at how they caused freight costs to rise or fall, but railroads also changed market dynamics by increasing accessibility and changing the distribution of population and of economic activity across counties. Producers in small towns, for example, found themselves better able to sell their goods to large cities.
The researchers measured this market access on a county level, building a network database of railroads and waterways for the years 1860–1900 to understand the relationship between a county’s productivity and its access to the growing national rail network.
Fogel’s methodology suggests that without the railroads, US productivity would have been about 3 percent lower in 1880 than it was. But Hornbeck and Rotemberg find that productivity would have been 25 percent lower than it was in 1880, and 28 percent lower than it was in 1890.
“The railroads shifted economic activity from some counties to others, along with increasing aggregate economic activity in the United States, and these effects combined to generate substantial national aggregate productivity gains that were worth roughly 50 years of technological innovation in this era,” they write.
Research finds that had railroads not been built, productivity in the United States in 1890 would have been, on average, 28 percent lower than it was. Counties in areas with market inefficiencies especially benefited from increased access to raw materials, workers, and consumers.
The productivity gains unleashed by railways cannot be explained by increased across-the-board spending on capital, labor, or materials, the researchers find. Instead, they argue, they may have stemmed from higher spending on manufacturing in counties where prices were artificially inflated by a single dominant business.
Take a county dominated by one textile company, which usually produced too few textiles to meet demand, meaning its profit margins were higher than they would have been in an efficient market. Greater economic activity in such a place, boosted by the railroads, would have had an outsize impact on revenues because the revenue-to-cost ratio of the textiles being produced was already higher than optimal. Increasing the number of linens sold with profit margins of 10 percent would have boosted productivity faster than selling more with 5 percent margins. The combination of new infrastructure and increased spending in these distorted-market counties thus boosted revenues.
The study suggests that market inefficiencies might be viewed from a new angle: yes, they are a problem to be eliminated, but they also represent a potential source for growth and explain why a new technology can have a bigger impact than expected.
“Market integration need not decrease market distortions,” write Hornbeck and Rotemberg. They point out that distortions today are “generally larger than in this historical era,” and that this suggests higher levels of economic activity—whether because of technology or increased government spending, private capital investments, or population growth through immigration—could produce an outsize boost to productivity.
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