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Saturday, 6 February 2010

From the Railroad to the Internet ... and Back Again

The Death of The Death of Distance?

Although our digitally networked world has seen some remarkable changes in the last two decades the need to physically move goods around the world has remained unchanged. I can communicate my thoughts to you without leaving my desk, but sending you this banana requires considerably more effort on my part. Anyway, I’m hungry, so keep your thieving minds off it.

Most research shows that the death of distance – the collapse in transportation and communication costs – first prophesised back in the nineteen nineties has failed to materialise. Although it’s certainly the case that the internet has caused some costs to fall others haven’t. This matters because the idea that global growth is mainly driven by technological innovations is almost certainly wrong: technology matters but what governments and people do matters more. And so it turns out that it’s the railroad, not the internet, that’s more important for our future prosperity.

The Madness of Trainspotting

At the start of the nineteenth century most of humanity had never travelled faster than the speed of the horse. Well, apart from a few intrepid alpine types who, in between bouts of competitive ultra-yodelling, decided to strap planks to their feet and started scaring goats with their uncontrolled downhill screaming. It was the invention of the steam engine that changed everything and after people got over their fear of asphyxiation and British politicians learned the hard way not to stand directly in the way of progress, a lesson they’re likely to have to relearn pretty soon, the development of railroads and steamships dramatically changed the shape of world trade.

It started, like so many things, in Britain where the growth of railways caught the attention of investors and led to a startling boom in the stocks of a largely unregulated industry in the 1840’s. In 1844 just 49 railways were sanctioned by Parliament but by 1846 this had risen to 219 as the mania took hold.

Unpredictably Barmy

From the lofty vantage point of hindsight it’s possible to see many of the contributory factors. Falling interest rates on government bonds diverted investment funds to riskier ventures in a search for higher returns. Then the combination of a good story and rising share prices on a tide of cheap money persuaded many smaller investors to place their savings in this once-in-a-lifetime opportunity. Opponents of the boom were derided and regulatory changes were blocked by an effective lobby group in the legislature. Finally the market collapsed as the government raised interest rates and the railway companies could no longer fund their expansion plans because everyone started buying government bonds instead of railroad stock.

Fortunately the lessons of this boom and bust, showing how cheap money can feedback into investor behaviour to cause irrational market movements, couldn’t possibly happen in our more enlightened times. Apart from when it does, of course.

It should, however, be noted that research such as that of Gavin Campbell seems to suggest that railroad stocks were not obviously overpriced before the bust – making the determinants of future policies for managing such booms more than usually difficult. After all, how do you deflate a boom you can’t detect?

Trade Costs and Global Trade

As David Jacks, Christopher Meisner and Dennis Novy have demonstrated the development of steam driven locomotives and ships had other effects – in particular they led to a dramatic collapse in international trade costs. This seems to have been the main factor in the great economic boom that kicked off in the 1870s and continued through the start of the First World War. Most of these benefits were seen in inter-continental trade between Europe and the Americas and Europe and the East. Once again Britain was at the heart of this, enforcing free-trade across the globe – if necessary by sending in the gunboats to make sure Johnny Foreigner kept their markets open for British manufactured goods.

Onset of the Great War ended the Great Boom and when normal business resumed afterwards it wasn’t as usual. With Britain economically crippled, Germany moribund under war reparations and the U.S.A. unwilling or unable to take up the slack global economic growth stuttered, spluttered and then stalled utterly. The failures of economics in the wake of the Great Depression still haunt our policymakers today but it seems that the interwar years saw trade costs actually rise as technological innovation slowed and international trade was weighed down by the costs of protectionism.

Globalisation, Transport and the Internet

It took the rather extreme measure of another world war to restart the economic engines and spark another near fifty year boom. This time, however, growth seems to have come from multiple sources – lowered trade costs due to inventions like containerisation and computerisation are a factor, but so has been a lowering of trade barriers and tariffs. Indeed recent research by Berthelon and Freund indicates that trade costs associated with distance have actually increased in the last quarter century.

Given that we’ve seen our own re-run of Railway Mania in the Dotcom Boom this is a tad surprising. The dematerialisation of many industries – think music and iTunes, books and the Kindle or even just your Internet stock dealing site – has clearly led to a reduction in transportation costs for many industries, and the virtual destruction of some previously impenetrable moats. Newspaper proprietors are still struggling with the whole idea of the internet, over a decade on. Yet, it appears, that not only is distance not dead it’s actually out partying.

What seems to lie behind this is that globalisation is having two effects. Firstly homogeneous goods – basically think stuff like fridges and ovens, will tend to be made in the place where it’s cheapest – which will be a complex equation involving labour costs, capital costs and transport costs. If it’s cheaper to make a microwave in Micronesia then ultimately that’s where it’ll happen. Secondly, as developing economies become wealthier their consumers want to, well, they want to buy stuff which needs to be shipped from wherever it’s made.

So the globalisation of the world through the medium of the internet is having two equal and not exactly opposite effects. Firstly, it exposes the world to all the exciting and cool stuff out there which all right minded, red blooded consumers should want to have and secondly it ensures that there’s a global market for shipping the stuff around.

The Return of Railway Mania

All of which means, in all probability, that we’re not going to see the death of distance anytime soon. Indeed, globalisation is likely to see more stuff being shipped further and, ironically, this means that mass transportation methods like, err, the railroad are probably much safer investments than ephemeral internet based corporations. It’s a hell of a lot harder to build a new set of railway tracks than it is to set up a new website.

This calculation is, presumably, behind Warren Buffett’s outright purchase of Burlington Santa Fe railroad for a cool $34 billion. Buffett, being Buffett, no doubt has his own calculations about the margin of safety this price brings Berkshire Hathaway but he is, as usual, investing on the basis of a company with a damn big anti-competitive moat and a business tail-wind.

Growth of railroads is one odd side-effect of the proliferation of fibre-optic cables and the Internet. It won’t be the last. All we can say for certain is that whenever people go mad and throw their money into stocks on nothing more than promises of future profits they may need a very, very long horizon. If you’d been willing to wait one hundred and fifty years then the Santa Fe railroad would have been a damn fine investment. Wonder how long it’ll be before the old Internet becomes the new railroad?


Related Articles: Going Dutch, The Benefits Of Sound Money, Why The Growth Of India And China Means Our Kids Should Do Media Studies, Copper At Morewellham Quay

6 comments:

  1. I don't know, I noticed a Radio Shack "Electronics Learning Lab" on the shelf, 2 miles from my house in California. It was $70. Before buying I did the ebay check ... $40 new in box. So I bought it from Florida instead, free shipping.

    I guess the question is whether this was "death of distance" or some sort of bizarre story of new inefficiency. The Soviet Union apparently shipped empty cardboard boxes on their trains to improve 'carloads'. Buying new retail products from Florida seems similar.

    ReplyDelete
  2. The trick is being able to think two steps ahead rather than just one step. That makes all the difference.

    Most people are not willing to put enough time into investing to be able to think more than one step ahead. Those people should be in index funds, in my view.

    Those who can think two steps ahead can do well picking individual stocks.

    We need both types of investors. There's nothing to be ashamed of in acknowledging that you only have time to think one step ahead.

    Rob

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  3. "At the start of the nineteenth century most of humanity had never travelled faster than the speed of the human horse."

    It's too bad we don't ride centaurs any more like we did in the nineteenth century.

    ReplyDelete
  4. "At the start of the nineteenth century most of humanity had never traveled faster than the speed of the human horse."

    Not quite.

    Sail ship speed > horse speed

    Also, not quite sure what a human horse is.

    Good post though

    ReplyDelete
  5. It's too bad we don't ride centaurs any more like we did in the nineteenth century.

    Also, not quite sure what a human horse is.

    Darn those proofreaders ;-/ 'Tis fixed, thanks.

    ReplyDelete