The Fall and Rise of Laissez-Faire in the United States, 1789-1900.

• Author: Folsom, Burton W., Jr.
• Position: Essay

Are free markets doomed to fail? Michael Munger and Mario Villarreal-Diaz suspect that they are. In "The Road to Crony Capitalism," these authors argue that inherent weaknesses in laissez-faire create long-run tendencies toward crony capitalism. "[I]t is at least possible," they claim, "that cronyism is intrinsic to and not separable from capitalism" (emphasis in the original). Thus, capitalism may have "a tendency--it's not inevitable or irreversible, but a tendency nonetheless--to devolve into crony capitalism." In other words, "the question of our age ... is simple: If real capitalism exists, is it sustainable? Or does capitalism in a democracy always devolve into corporatist cronyism?" (emphasis in the original).

To address these important questions, let's look at U.S. history from its beginning in 1789 to 1900. "A page of history is worth a volume of logic," as Justice Oliver Wendell Holmes observed in New Tork Trust Co. v. Eisner (256 U.S. 345 [1921]). If we do so, we see that the United States did not, as Munger and Villarreal-Diaz imply, "devolve into corporatist cronyism" but jumped into it immediately in George Washington's presidency. Let me first outline the fall of laissez-faire in the United States from 1789, its first year as a nation, to the Civil War era, two generations later. The crony capitalism began with tariffs and a central bank and then expanded into ever-larger federal subsidies, first to fur trading and then to road building, steamships, and railroads.

The trigger for America's first federal interventions was President Washington's secretary of the Treasury, Alexander Hamilton, who quickly secured a tariff on imports, some of which was justified to protect "infant industries." But as economic historian William Letwin has observed, "The infant industries of 1789, which were supposed to need protection only until they learned to stand on their own feet, were not infants thirty or forty years later, and yet tariff protection was still requested and granted" (1961, xx, 14-15).

Next, Hamilton proposed that a large central bank, the Bank of the United States, be trusted with the revenue from the tariff. More crony capitalism would be inevitable here because one-fifth of the directors of this bank would be appointed by the government, and the Bank of the United States would be encouraged to make loans to businesses approved by the board. In other words, the directors of the bank could and did loan money to friends or others with political influence.

With some crony capitalism under way, Hamilton then issued a "report on manufactures" in which he defended direct subsidies, or "bounties" as he called them, to new industries. Hamilton labeled these subsidies "one of the most efficacious means of encouraging manufactures, and ... in some views, the best." In fact, he insisted, "There is no purpose to which public money can be more beneficially applied, than to the acquisition of a new and useful branch of industry" (quoted in Letwin 1961, 16-18).

With the door open to federal intervention, Washington chose to create and subsidize a government-operated fur-trading company. Fur trading involved mainly beaver pelts, which were converted to hats that Americans sold widely around the world. Fur trading nicely fit Hamilton's definition of "a new and useful branch of industry" to be supported, but Washington was even more concerned with national defense. Indians were crucial in trapping beaver and selling their pelts; the president wanted Americans, not the British in Canada, to dominate the fur trade to prevent British encroachment on American land. In 1795, Washington secured $50,000 from Congress as emergency money to operate a series of fur-trading "factories" throughout the Northwest Territory (modern-day Ohio, Indiana, Illinois, Michigan, and Wisconsin) and the American South. These fur factories would, Washington hoped, "bring in a small profit, ... and fix them [the Indians] strongly in our interest." In later years, Congress raised the subsidy to $300,000, a large expense for a new nation and one that tested the government's ability to run a profitable business. (1)

Here is how the government fur-trading system worked. The Office of Indian Affairs used the subsidy to set up the trading posts (usually near military forts), stock them with goods, and pay American agents to buy, store, and transfer furs from the trading posts to Washington, D.C., where they would be sold at auction to "bring in a small profit," as President Washington expected.

Almost from the start, however, the fur-trading factories struggled. Private American traders and the British actively competed for the Indians' business throughout the Great Lakes area. And the private American traders captured the bulk of the fur trading on the American side of the Great Lakes. The Office of Indian Affairs steadily lost market share because its leaders often stocked their factories with items they wanted the Indians to buy rather than with items the Indians actually wanted. Thomas McKenney, who was appointed to head Indian Affairs in 1816, especially campaigned for the Indians to become farmers, not hunters, and he filled the factories with hoes and plows--as well as with Jews' harps and even a Chinese Mandarin dress to "amend their heads and hearts." The Indians, in response, traded with the British and private American traders, who gladly sold the Indians what they really wanted: muskets, powder, blankets, whiskey, and pots and pans. (2)

Among the American traders, John Jacob Astor emerged as the largest. In fact, his business greatly surpassed that of the subsidized factories after 1808. Astor accepted Indians as they were and valued them as fur trappers. He wisely hired agents to live with the Indians, extend them credit when needed, and supply them in trade with the best muskets and blankets on the market. Reaping an abundance of furs, Astor then developed a worldwide trading network. He sold beaver hats to fashionable Europeans and bear rugs to the Chinese for warmth in their unheated houses. He would bring back various imports from Europe and tea from China. (3)

With Indian Affairs' market share dwindling, Thomas McKenney urged Congress to ban private fur trading. When that failed, he tried to get Congress to impose high licensing fees on all private American fur traders. "Armies themselves," McKenney argued, "would not be so effectual in regulating the native Inhabitants as would a state of dependence on the Government for their commercial intercourse." Sure, McKenney admitted, a monopoly "embraces the idea of compulsion," but "the power over the Indians is covetted [sic] only for their good--and also to prevent them from doing harm." (4)

Astor, in self-defense, urged Congress to investigate the government-subsidized...