Railroading Economics: The Creation of the Free Market Mythology

Published by EH.NET (January 2007)

Michael Perelman, Railroading Economics: The Creation of the Free Market Mythology. New York: Monthly Review Press, 2006. 238 pp. $20 (paperback), ISBN: 1-58367-135-8.

Reviewed for EH.NET by Richard Vedder, Department of Economics, Ohio University.

The good news about Michael Perelman’s new book is that it is a highly readable, lucidly written, and provocative account of the evolving American economy. Moreover, readers of this site would be pleased that this is a rare economist who draws very heavily on insights from economic history and even the history of economic thought in reaching conclusions about the contemporary American economy. Also, the book has lots of solid footnotes showing a serious appreciation of much of the relevant scholarly literature of the past century or more.

Alas, the bad news is that Perelman is almost certainly wrong, and I suspect most American scholars reading his book would agree. He believes the fundamental core of microeconomic theory as taught by more than 95 percent of American academic economists is misguided and that the American economy is in real decline. A radical economist (who has published more in the Review of Radical Economics — at least seven papers — than in any other scholarly journal), Perelman avoids most of the maddening invective and polemics that sometimes pervades heterodox works, but in the final analysis he thinks Americans live in a society run by a bunch of greedy financiers who seriously exploit workers and cause enormous waste.

According to Perelman, classical economics emerged out of an agrarian society where the presumption of pure competition was fairly reasonable. Over time, however, massive capital-intensive businesses evolved, notably the railroads, with very high fixed costs. The neoclassical notion that profit-maximizing firms would produce where marginal costs equaled marginal revenue and price (in pure competition) simply did not fit the reality of these new natural monopolies. Competition was destabilizing, led to overinvestment, and paved the way for unscrupulous financiers like Jay Gould. In Perelman’s view, “the increasing relative importance of fixed costs means that … competition … would lead to utter chaos” (p. 46). A group of “railroad economists” or corporatists understood all this, but they were largely ignored by conventional economists who developed a “quasi-religious” and “ideological” (p. 99) fervor towards their theoretical models, a fervor that persists today.

Perelman thinks that in pursuing competition, prices were forced so low that many railroads were forced into bankruptcy, much as is happening in airlines today. This opens the door for the “financial capitalists” who make money reducing competition (via mergers) and reorganizing bankrupt companies, getting rich in the process and hurting workers of the involved companies. The Enron/WorldCom problems of the early twenty-first century are not that different from those created by J.P. Morgan organized mergers of a century earlier, best symbolized by the formation of U.S. Steel.

In Perelman’s eyes, the instability arising from the lack of realization of the importance of fixed costs, the machinations of financial interests, and so forth, have caused internal contradictions in capitalism. He opines that “an economy built increasingly on finance is a disaster waiting to happen” (p. 198), concluding “I look forward to the day when we no longer rely on competition for monetary rewards … when cooperation and social planning replace the haphazard world of the market place” (p. 200). In Perelman’s world, “success will … depend upon the education and empowerment of workers rather than their exploitation” (p. 200).

As neo-Marxist accounts go, this one is far less polemical and hysterical than some, but it still simply does not accord with critical facts. Business is not beset with continually rising relative fixed costs, for example, a basic assumption of the book. The largest and most successful businesses of modern times — the Microsofts, Wal-Marts, Googles, major pharmaceutical companies, etc., are mostly firms with little debt and often even large cash hoards. Fixed costs are a trivial part of expenses. Many so-called natural monopolies (e.g., cable and phone companies, electric utilities) are actually becoming more competitive over time with technological change, and the share of American workers employed by large (Fortune 500) firms has declined sharply. Moreover, Perelman’s characterization of contemporary economist’s acceptance of Marshallian economic theory is badly distorted, as he writes as if economists have largely ignored imperfect competition, information costs, etc., while that is very far from the truth.

Despite Perelman’s assertions, by any standard measures, economic instability has declined sharply in the last sixty years. For example, the standard deviation on the annual unemployment rate or growth rate of real GDP was far lower in the last half of the twentieth century than the first half. Two-thirds of a century has passed since we had a year with a ten percent unemployment rate, while there were seventeen such years in the fifty years from 1891 to 1940. “Crises” and “depressions” predicted by Perelman are happening less often and with smaller levels of severity, not greater as the analysis in this volume seems to predict. Real average consumption per American has risen two percent a year in the over one hundred years since the “railroad economists” inveighed about excessive competition, hardly a sign of economic decline or massive worker exploitation. America’s immigrant problem is one of finding human ways of excluding newcomers, not obtaining them, a sign the nation retains a role as a magnet to people who come from economies that, on average, are far less capitalist than America. Where market’s have been suppressed, in places like North Korea or Cuba, people are poor relative to neighbors living in market economies with all of the speculation, financial excesses, and occasional mal-investments that so disturb Perelman.

Richard Vedder, Distinguished Professor of Economics at Ohio University, is coauthor of the just released The Wal-Mart Revolution (AEI Press, 2006). His next book will be on income growth, equality and public policy in the United States.